What is MIRR (Manager's Initial Rate of Return)?

Question

I was reading a thread on here and someone brought up MIRR (Manager's Initial Rate of Return) in passing. What is this, what does it tell me, and how do I calculate it? Why do I want to know this?

Thank you for any responses!

Roy N. · Answer

Dave:

Every investment will be disposed - either you will sell it, or your estate will.  If the assets are owned by a company, the company itself will eventually be sold or wound down.  Furthermore, you should never make an investment without an exit strategy and preferably with more than one.

(M)IRR is extremely useful to the buy-and-hold real estate investor, as it is to any business owner/investor, when underwriting a potential investment.    Will I know with precision the FMV of my investment 5yrs, 10yrs, 20yrs down the road?  No, but I do not need to be precise.   What I will know is the rate of return I require (to meet my hurdle, exceed my opportunity costs, make my wife happy ... whatever).   Furthermore, I can determine at what value I would need to sell the asset at a given point in time to achieve my required return.   Approaching things in this direction, (M)IRR is important in that it can tell me when I should dispose of an asset to maximize my return.

Dave Toelkes · Answer

IRR is not really useful to the buy and hold investor.  IRR calculations are done on the assumption that the asset is sold at the end of the holding period, and, that the last income stream is the cash received from the sale of the asset.  who can accurately predict the FMV of a rental property in ten years?  While IRR and MIRR calculations are easy to do in a spreadsheet program, they are not terribly useful decision tools for a buy and hold investor that never sells the property.

Roy N. · Answer

@Therese V.

Here are two simple examples of IRR and MIRR calculations.

I would recommend you pickup a copy of @Frank Gallinelli's book "What Every Real Estate Investor Needs to Know About Cash Flow"

Any chance your source had confused Financial Management Rate of Return (FMRR) and Modified Internal Rate of Return (MIRR)?

Roy N. · Answer

@Alan Roebuck

You could go through the exercise of calculating {M}IRR using real data for a past period.   However, since you are looking in the rearview mirror, you have the added advantage of knowing the actual rates of return and reinvestment for each of the years being examined, so could precisely determine your real rate of return over the period.

Roy N. · Answer

@Dave Toelkes

I like these discussions as they give everyone cause to think and reflect.

Cash-on-Cash (NOI /{ Initial cash or capital investment}) suffers from the same single-point-in-time limitations that the CAP rate and CRM ratios do.  It gives me a good picture of the cash-flow in the most recent fiscal period (typically a year), but to carry that forward 2, 3, 5 or 10 years encompasses as many assumptions and predictions as does calculating an internal rate of return.

Now, you can discount future cash flows and endeavour to calculate a series of CoC values ... or, perhaps an average CoC over a period of time ... but you are now getting into an exercise which is not entirely different than determining/projecting a rate of return :-)  Naturally the cash return is a component of overall rate of return.

Because it does not paint a full picture of how the two investment compare beyond the current point in time and it does not help identify exit points where the investment could be - or should be - disposed.

After all that, I'm sure it will come as no surprise to you that we do not make an investment decision based on a single ratio or metric.  In fact we look at both (M)IRR and {a series of} Cash-on-Cash ratio(s).  Furthermore, since we put little emphasis on appreciation - we typically analyse a property with the assumption of zero (or even negative) appreciation - a strong cash return is essential to an acceptable (M)IRR.

Alan Roebuck · Answer

Could the MIRR be used retrospectively, to judge the profitability of an investment you've had for several years?

My wife and I have owned a couple of single family homes as rental properties for a few years, and we want to get some hard numbers on how valuable they are as investments. Someone recommended the IRR as a way to measure profitability, but all discussions of IRR that I have seen are for a prospective investment.

Dave Toelkes · Answer

@Roy N.

IRR and MIRR calculations are both based upon the present value of an income stream that will be earned in the future.  It may make one feel good to know that the discount rate for a dollar earned in the future is 12%, but for the IRR calculation to reflect anything near an actual outcome, the income must be reinvested at 12% as it is received for the duration of the holding period used to compute the IRR.  Recognizing that this is not always possible, MIRR calculations use a rate of return for reinvested income that is closer to reality.

IRR and MIRR can each be used to evaluate the relative merits of two or more potential investments over time, but both calculations depend upon some predictions that will likely not reflect an actual outcome.  Instead, why not just use a cash on cash return calculation to evaluate the merits of competing investments?

Therese V. · Answer

Thank you for the sources!

Therese V. · Answer

Hmm, maybe the person mentioning it had an autocorrect issue?

Anyways, can you give me an example with numbers of what that means? Why would I want to know either of those?

For the rate of return, which version do we use? Does that account for the purchase price or just the amount spent OOP? (presuming a mortgage)

Roy N. · Answer

@Therese V.

That's a new version of MIRR (Modified Internal Rate of Return) to me.

IRR (Internal Rate of Return) assumes that all cashflows are reinvested in the business at the rate-of-return.

MIRR assumes all positive cash flows are reinvested at the business' cost of capital and all initial outlays are financed at the business' financing costs.   Essentially it is IRR modified to account for the difference between re-investment rate and the rate of return.

What is MIRR (Manager's Initial Rate of Return)?

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