Should deals be analyzed using IRR or MIRR?

Question

Hey all,

I'm trying to figure out if there are any advantages to using IRR instead of MIRR in an investment analysis. From what I can find it seems like there isn't, but I haven't found any sources definitively making that claim. The way I see it is that MIRR accounts for IRR's two short-comings: 1) potentially having multiple solutions when the cash flow from the investment goes from positive to negative and vice-versa, and 2) assuming that you can reinvest your positive cash flow from the investment at the same rate of return you expect your investment to make (the IRR). And both values must be calculated using software so it isn't any harder to determine their values (besides deciding your safe rate and reinvestment rate).

I appreciate the importance of IRR as a form of training wheels since the concept is already difficult to grasp; someone learning shouldn't try to jump straight to understanding MIRR. But when analyzing deals in any real-world situation, it seems like MIRR should always be used. I'd love to hear everyone's thoughts on this.

Mike Dymski · Answer

While you are dedicating mind share to this nuance, less intelligent people are getting deals done.  Use either one and you will be way ahead of most investors.

Austin Petrie · Answer

@Bill F. I really appreciate the detailed response, there are a lot of gems of knowledge I was able to get from it. Also that's a great quote, I never heard it before.

Austin Petrie · Answer

Haha very fair point @Mike Dymski. Definitely don't want to miss out on good opportunities from over analyzing everything.

Bill F. · Answer

@Austin Petrie Great question and I agree that MIRR is, generally speaking, a more useful measure than IRR.

That being said, they are both trying to model the future of two or three separate investment alternatives, a truly difficult task, and we have to remember that "All models are wrong, some models are useful" At the end of the day, the inputs and assumptions of the calculations are much more important that the actually math. Knowing that once you cross north of 5th St. you need to increase your vacancy credit by 1% will have a much larger impact on your true returns than using MIRR vice IRR.

The nearest I can figure why MIRR doesn't get more traction on BP is that most people don't really understand IRR beyond the definition "the rate that sets the NPV of future cash flows to zero", so the factors that you pointed out don't make sense. To a lot of people MIRR and IRR are numbers instead of the end of a modeling process. Also buying and selling SFR isn't that complicated of a investment so simple year by year CoC calculations can give an accurate enough picture for the vast majority of people on BP.

I saw your post about FMRR and I agree, it's the most accurate. Its not used because, and at least from my limit experience, I've never come across two investment that had such similar characteristic that I needed to get that level of precision in my measurement. Also, excel gives us IRR, xIRR, MIRR, xMIRR, so convenience definitely plays a role.

I view all the calculations (payback period, CoC, DCF, IRR, MIRR, FMRR, ect...) as tools in a tool box and use them when called for. I can take a simple expense ratio and cap rate to get to a ball park value from the GSR  in about 45 sec with my phone. At times, that's more useful than a full on model that tells me my free cash flow in year 7.

At the end of the day, these metrics help us make a decision to write a check and are not an end in and of themselves.

Andrew Kerr · Answer

Hi @Austin Petrie - yeah early on I thought about including time value, or present value & future value, but I found keeping things simple worked best. My focus was to have the financial capacity or cash flow to stop working if I wanted to. So I simply compared investing in either equities or real estate. I found with real estate I had more control, and higher & more consistent gains so I focus on that. And my main driver an investment is what CoC return is.

Now with that said, I have started to look at more investments with a lower CoC (as I have more financial capacity now) and a higher IRR. This could be from buying an asset that needs to be re-positioned, so it will have lower cash flow while it is stabilized, but a higher overall return. As an example, there is a project I am working on that might only give me a 3-4% CoC return while it is stabilized, but my IRR over 5 years will be around 25+%.

Austin Petrie · Answer

@Andrew Kerr oh ok cool, that makes sense. Thanks for elaborating on that.

Austin Petrie · Answer

Hey Andrew, thanks for the response that's an interesting take on things! I'm curious, do you use another metric to take into account the time value of your money alongside CoC return or have you found that CoC return has suited you well enough even without that factor?

Andrew Kerr · Answer

Hi @Austin Petrie - While IRR and MIRR are important, I prefer CoC return. IRR is useful but will figure in appreciation and equity paydown. Then I might not reinvest capital, or if I have a group of partners we might have different reinvest criteria, so I don't really ever look at MIRR.

When I run a scenario, I want to see IRR simply from me having a long term target I want to hit. But I really focus on my CoC return as this is what gives me that financial freedom. CoC return is what pays the bills so to speak. Also, most of the cash partners I have will look at IRR, but again, they tend to care more about the cash yield, so we focus on CoC.

Should deals be analyzed using IRR or MIRR?

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