I find that most investors want to see a property's projected IRR (internal rate of return) over the anticipated life of the deal. The biggerpockets rental property calculator does not provide IRR calculations. Might someone recommend a robust rental property analysis tool that includes the IRR calculations?
IRR calculations in Excel are very easy. Unfortunately though, it can be difficult to generalize it into an online tool, as the calculation requires a lot more information than what a standard analysis tool has.
For example, IRR will be very sensitive to when capex expenses are expected to be spent, how long you'll keep the property, whether you roll the cashflow back into an investment vehicle that returns a similar rate, etc. Even breaking down monthly vs annual inflows/outflows can have a big effect on the IRR.
But again, you can create this in Excel for a new property in about 30 seconds if you know what you're doing...
Thanks for your reply. I do know how to do an IRR in a spreadsheet but the big efficiency I am looking for a one stop tool. And if you think about it, if I can set this up (takes a bit more than 30 seconds), biggerpockets or someone else with a great tool can set it up. It would be easy to footnote the assumptions. Most people take a standard approach to the variables you mention. So, hopefully, I can find a solution other than the spreadsheet approach. The other problem with the spreadsheet is that people are suspect of numbers coming from a private spreadsheet.
Originally posted by @George Wollner :
The other problem with the spreadsheet is that people are suspect of numbers coming from a private spreadsheet.
If this is for marketing a property to others, I certainly wouldn't include IRR as a component of that marketing plan. IRR is *very* sensitive to the data, and using data that isn't specific to a buyer's scenario is very unlikely to be anywhere close to accurate.
For example, how long of a hold period will you assume in your IRR calculation? How will you determine sales revenue? How will you time capital infusions of capex expenses?
Most importantly, IRR makes certain assumptions about how cash flow is reinvested...there are lots of ways that cash flow can be reinvested, so an MIRR calculation is more appropriate...but without knowing a specific investor's reinvestment plan, even that is useless.
How do you plan to address these things in your generic model?
I have reviewed countless real estate investment proposals which include IRR projections. The key is to be totally transparent with the underlying assumptions. Why let pursuit of the perfect kill the good? While most of the investors I know (a) don't fully understand IRR and (b) recognize that it is based on key assumptions - if it is provided by a trusted party and the assumptions are spelled out -- they know that the IRR number is one of a couple key indicators that provides good context around the deal potential.
Originally posted by @George Wollner :
Why let pursuit of the perfect kill the good? While most of the investors I know (a) don't fully understand IRR....
Is the prospectus for a deal you'll be doing/controlling (a private placement or syndication)? Or are you putting together a deal sheet in order to try to sell a deal to another buyer?
If it's the first (you'll control the deal from purchase to sale), IRR is just fine, as you have control over the decisions and can take steps to ensure you can meet that IRR. And you can ignore the rest of this post.
But, if you're using IRR on a deal sheet for a deal that will go to other investors, those two sentences you wrote above contradict each other. For those who don't fully understand IRR, providing a number that is based on generic assumptions isn't perfect, nor is it even good. It's misleading. Horribly misleading if someone knowledgeable wants it to be.
Which is why you've seen it used on "countless" other prospectuses -- IRR using the "right" assumptions can make a deal look much better than what it would most likely look like in real life. So, sellers include it to make the deal appear better than it really is.
For example, I assume you use IRR and not MIRR, so you assume the reinvestment rate is the same as the return on the underlying asset. But, in reality, do you know ANYONE who reinvests their cash flow each month at the same rate as the underlying investment?
More likely, they either use it to live off of (0% reinvestment), use it to pay down their mortgage (4-6% reinvestment) or save it up to buy another investment down the road (0% reinvestment for some period of time and then reinvestment at the same rate as the underlying asset). But, if you're giving them an IRR metric, you're assuming they're doing something much more beneficial than any of those things...which is misleading.
For those who understand IRR -- and specifically for those who understand that a small change in the inputs will often have a large change in the outputs -- you don't need to include the metric on the prospectus, as the recipient will calculate their own returns. But, for those who don't understand IRR, you're doing them a disservice by providing what is going to be inaccurate data 99% of the time. Worse yet, they won't understand that.
If you want to provide something generic, use MIRR with a reinvestment rate at whatever rate the underlying mortgage interest rate is (assumption that cash flow will be used to pay down mortgage). While it still won't be applicable to 99% of your prospective buyers, at least you won't be overstating the returns nearly as much.
Most likely, nothing I said above will change what you do. But, please don't fool yourself into believing that you're doing your buyers a service by including this information. The smart ones will ignore it, and the ignorant ones will be misled.
Thanks for a great explanation of IRR and MIRR @J Scott