How Is IRR/XIRR Affected By Refinancing & Selling?

Investor · Lansing, MI · Member since 2021 · 55 posts · 22 votes

Hey Everyone,

I've been building an Excel financial model that can quickly analyze potential value-add multifamily projects and I've run into an issue that I wasn't expecting - when calculating the returns, do you take into account both the refinance and sale proceeds, along with the cash flow? Or just one of the capital events along with the cash flow?

Currently, when I include both refinance and sale proceeds, I get an unrealistic XIRR of 49%, while the average cash flow throughout the investment (7-year hold period) sat around 8%, and this seems incorrect to me.

Please let me know some feedback, I can elaborate more if needed. Thank you!

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Joshua ChristensenPro Member

Real Estate Broker · Albuquerque, NM · Member since 2015 · 281 posts · 232 votes

Quote from @Gabe Goudreau:

Quote from @Joshua Christensen:

Quote from @Gabe Goudreau:

Hey Everyone,

I agree with David.

IRR is sensitive to capital events. Does your refinance include a return of capital at that time? If so, your IRR is going to be affected in a higher way. If you pay back all the upfront capital needed to fund the deal, the return becomes infinite after that, so that plays heavy.

When I underwrite my deals, I plan on 5 years without a refi. It's a more "pure" approach, then if I like the numbers, I'll move forward. A refi only juices my returns in that scenario if I refin in less than the 5 year projection. Underwrite for the worst you'll accept and then perform to your best ability to maximize over time.

Yes, it includes a return of capital at that time. Here is an ss of what I have currently, this connects to other tabs of the model. The ($597k) is the initial equity invested, the $220k is proceeds from a refinance, and the $1.2 MM is sale proceeds. These are based on fictional numbers, assuming a 7-cap valuation at refinance & sale. I will run through an actual deal soon, just trying to fine-tune the model in the meantime.

Find a model that you can run the exact same test numbers through that you trust has accurate measurements of IRR. Then model yours to a similar approach. It becomes your "control" to compare against.

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Account Closed
Real Estate Broker · Minneapolis · Member since 2024 · 16 posts · 10 votes
2y
Generally, yes all capital events count towards IRR calcs.
It's technically possible to have a high IRR number with average cash flow numbers if most of the returns are coming from the capital event(s).
That said, 49% IRR seems too good to be true. IRR estimates are extremely sensitive to the exit cap assumptions. Without knowing much about the project you're looking at, that's where I'd look in the model
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Joshua ChristensenPro Member
Real Estate Broker · Albuquerque, NM · Member since 2015 · 281 posts · 232 votes
2y
Quote from @Gabe Goudreau:

Hey Everyone,

I've been building an Excel financial model that can quickly analyze potential value-add multifamily projects and I've run into an issue that I wasn't expecting - when calculating the returns, do you take into account both the refinance and sale proceeds, along with the cash flow? Or just one of the capital events along with the cash flow?

Currently, when I include both refinance and sale proceeds, I get an unrealistic XIRR of 49%, while the average cash flow throughout the investment (7-year hold period) sat around 8%, and this seems incorrect to me.

Please let me know some feedback, I can elaborate more if needed. Thank you!

I agree with David.
IRR is sensitive to capital events. Does your refinance include a return of capital at that time? If so, your IRR is going to be affected in a higher way. If you pay back all the upfront capital needed to fund the deal, the return becomes infinite after that, so that plays heavy.
When I underwrite my deals, I plan on 5 years without a refi. It's a more "pure" approach, then if I like the numbers, I'll move forward. A refi only juices my returns in that scenario if I refin in less than the 5 year projection. Underwrite for the worst you'll accept and then perform to your best ability to maximize over time.
1 Reply
Gabe Goudreau
OP
Investor · Lansing, MI · Member since 2021 · 55 posts · 22 votes
2y
Quote from @Account Closed:

Generally, yes all capital events count towards IRR calcs.
It's technically possible to have a high IRR number with average cash flow numbers if most of the returns are coming from the capital event(s).
That said, 49% IRR seems too good to be true. IRR estimates are extremely sensitive to the exit cap assumptions. Without knowing much about the project you're looking at, that's where I'd look in the model
Thank you, still going through with fake numbers and entry/exit cap rates to make sure the formulas work correctly. I will run through a real underwriting and see how the cap rate assumptions affect this.
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Gabe Goudreau
OP
Investor · Lansing, MI · Member since 2021 · 55 posts · 22 votes
2y
Quote from @Joshua Christensen:

Quote from @Gabe Goudreau:

Hey Everyone,

I've been building an Excel financial model that can quickly analyze potential value-add multifamily projects and I've run into an issue that I wasn't expecting - when calculating the returns, do you take into account both the refinance and sale proceeds, along with the cash flow? Or just one of the capital events along with the cash flow?

Currently, when I include both refinance and sale proceeds, I get an unrealistic XIRR of 49%, while the average cash flow throughout the investment (7-year hold period) sat around 8%, and this seems incorrect to me.

Please let me know some feedback, I can elaborate more if needed. Thank you!

I agree with David.
IRR is sensitive to capital events. Does your refinance include a return of capital at that time? If so, your IRR is going to be affected in a higher way. If you pay back all the upfront capital needed to fund the deal, the return becomes infinite after that, so that plays heavy.
When I underwrite my deals, I plan on 5 years without a refi. It's a more "pure" approach, then if I like the numbers, I'll move forward. A refi only juices my returns in that scenario if I refin in less than the 5 year projection. Underwrite for the worst you'll accept and then perform to your best ability to maximize over time.

Yes, it includes a return of capital at that time. Here is an ss of what I have currently, this connects to other tabs of the model. The ($597k) is the initial equity invested, the $220k is proceeds from a refinance, and the $1.2 MM is sale proceeds. These are based on fictional numbers, assuming a 7-cap valuation at refinance & sale. I will run through an actual deal soon, just trying to fine-tune the model in the meantime.
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Joshua ChristensenPro Member
Real Estate Broker · Albuquerque, NM · Member since 2015 · 281 posts · 232 votes
2y
Quote from @Gabe Goudreau:

Quote from @Joshua Christensen:

Quote from @Gabe Goudreau:

Hey Everyone,

I've been building an Excel financial model that can quickly analyze potential value-add multifamily projects and I've run into an issue that I wasn't expecting - when calculating the returns, do you take into account both the refinance and sale proceeds, along with the cash flow? Or just one of the capital events along with the cash flow?

Currently, when I include both refinance and sale proceeds, I get an unrealistic XIRR of 49%, while the average cash flow throughout the investment (7-year hold period) sat around 8%, and this seems incorrect to me.

Please let me know some feedback, I can elaborate more if needed. Thank you!

I agree with David.
IRR is sensitive to capital events. Does your refinance include a return of capital at that time? If so, your IRR is going to be affected in a higher way. If you pay back all the upfront capital needed to fund the deal, the return becomes infinite after that, so that plays heavy.
When I underwrite my deals, I plan on 5 years without a refi. It's a more "pure" approach, then if I like the numbers, I'll move forward. A refi only juices my returns in that scenario if I refin in less than the 5 year projection. Underwrite for the worst you'll accept and then perform to your best ability to maximize over time.

Yes, it includes a return of capital at that time. Here is an ss of what I have currently, this connects to other tabs of the model. The ($597k) is the initial equity invested, the $220k is proceeds from a refinance, and the $1.2 MM is sale proceeds. These are based on fictional numbers, assuming a 7-cap valuation at refinance & sale. I will run through an actual deal soon, just trying to fine-tune the model in the meantime.

Find a model that you can run the exact same test numbers through that you trust has accurate measurements of IRR. Then model yours to a similar approach. It becomes your "control" to compare against.
2 Reply
Account Closed
Real Estate Broker · Minneapolis · Member since 2024 · 16 posts · 10 votes
2y
Quote from @Gabe Goudreau:

Quote from @Joshua Christensen:

Quote from @Gabe Goudreau:

Hey Everyone,

I've been building an Excel financial model that can quickly analyze potential value-add multifamily projects and I've run into an issue that I wasn't expecting - when calculating the returns, do you take into account both the refinance and sale proceeds, along with the cash flow? Or just one of the capital events along with the cash flow?

Currently, when I include both refinance and sale proceeds, I get an unrealistic XIRR of 49%, while the average cash flow throughout the investment (7-year hold period) sat around 8%, and this seems incorrect to me.

Please let me know some feedback, I can elaborate more if needed. Thank you!

I agree with David.
IRR is sensitive to capital events. Does your refinance include a return of capital at that time? If so, your IRR is going to be affected in a higher way. If you pay back all the upfront capital needed to fund the deal, the return becomes infinite after that, so that plays heavy.
When I underwrite my deals, I plan on 5 years without a refi. It's a more "pure" approach, then if I like the numbers, I'll move forward. A refi only juices my returns in that scenario if I refin in less than the 5 year projection. Underwrite for the worst you'll accept and then perform to your best ability to maximize over time.

Yes, it includes a return of capital at that time. Here is an ss of what I have currently, this connects to other tabs of the model. The ($597k) is the initial equity invested, the $220k is proceeds from a refinance, and the $1.2 MM is sale proceeds. These are based on fictional numbers, assuming a 7-cap valuation at refinance & sale. I will run through an actual deal soon, just trying to fine-tune the model in the meantime.

Some additional thoughts here.
1) In theory, you would refinance after the value-add project is completed and the asset is stabilized. So in real life, project cash flows shouldn't grow much more than inflation once it's been stabilized.
2) When you refinance, you're increasing your debt service burden. So in most cases operating cash flow will actually decrease because you're servicing more debt (this is offset by the cash out refi so it's still usually a net gain).
These reasons are probably why your model is looking a bit off. In the screen shot you shared it looks like operating cash flow continues to grow at roughly the same pace after the refi which isn't likely to happen on real deals.
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Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
2y
Adding value is...valuable! I have been replying to posts for eight year and trumpeting the benefits and risk mitigation of adding value and people respond to me like I've lost my mind.
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