Internal Rate of Return - IRR - Real Estate

 

            The Internal Rate of Return or IRR calculation put simply measures the average annual

            yield on an investment.  For an income producing property, the internal rate of return

            calculation uses the initial amount invested in the property, a series of projected cash flows

            which are usually after-taxes, and a projected After-Tax Sales Proceeds amount in a given

            year. 

 

            Lets look at an example.  If we were calculating the internal rate of return for an income

            producing property 5 years in the future, we would use the Initial Investment amount or the

            amount of money put down on the property, the projected After-Tax Cash Flows for each of the

            five future years and the After-Tax Sales Proceeds in year five, the final year, to calculate an

            average annual return on our initial investment amount over the five year period.  The On

            Target real estate model calculates an After-Tax IRR in years 1 through 10 using this method.  

 

            You should be aware of the following when using the IRR to measure the return on an

            investment.  If in year 5, you have a return of 20 %, the internal rate of return calculation

            assumes that you made 20% on your cash flows for each of the five years.  You may or

            may not be able to make 20% on your cash flows.  The IRR calculation can therefore

            sometimes exaggerate your average return on an investment.

 

            The Property Analysis real estate model also calculates a MIRR, or modified internal rate of return.

            When calculating the MIRR for Future Wealth with the  real estate model, we

            allow you to enter what rate of return you think you will make on your cash flows.  The     

            MIRR for Future Wealth can therefore provide a more accurate return on cash flows for  

           each year since you determined the (interest) rate at which the cash flows get ran forward at.

 

           The On Target 2.01 real estate analysis software calculates both an internal rate of return

           and a modified internal rate of return.  The internal rate of return is calculated for each year    

           over a ten year period and is based on investor growth rate assumptions for income,

           expenses and appreciation. 

 Tien and Jim 

Your Real Estate Partners