Lack of IRR in Rental Property Calculator

[George Wollner]

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?

thanks -gw

[J Scott]

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?

Unlikely.  

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.