Insights

Regression – no, it’s not what your family and friends accuse you of when you want to trade in the mini-van for a two-seater stick-shift convertible (well, maybe it is, but that’s a topic for a different article). If you’re familiar with our RealData software, my online video courses, and my other blog posts here, then you know that I’m usually talking about income-producing property like multi-family, retail, office, or the like — seldom about single-family homes. And when we estimate the value of most income properties, we typically do so by looking at their income stream.

From our experience, it appears that Internal Rate of Return (IRR) is the metric of choice for many, if not most, real estate investors. However, you may be aware that there are a few issues with IRR that can cause you some vexation: If you expect a negative cash flow at some point in the future, then the IRR computation may simply fail to come up with a unique result; and with your positive cash flows, IRR may be a bit too optimistic about the rate at which you can reinvest them. For these reasons, a variation on IRR, called Modified Internal Rate of Return (MIRR), can be very important. When you see how it works, then you’ll also see that it gives you the opportunity to deal with IRR’s shortcomings.

We usually think of Return on Equity (ROE) as a straightforward investment measure. That’s understandable, because the traditional method of calculating ROE is pretty clear cut: Take your cash flow after taxes and divide it by your initial cash investment.

One topic that often gets less attention than it deserves from real estate investors, however, is resale. Some tend be dismissive, looking at resale as speculation, but many others simply find it difficult to focus seriously on the matter of selling a property they haven’t yet purchased.It may take a little extra discipline to work a consideration of resale into your investment mindset, but it is just such discipline that often separates the successful investor from the sorry.

Not all partnerships include a preferred return but, in those that do, its purpose is to counterbalance the risk associated with investing capital in the deal. Typically, the investor is promised that he or she will get first crack at the partnership’s profit and receive at least a X% return, to the extent that the partnership generates enough cash to pay it. In most partnership structures, the cash flow is allocated first to return the invested capital to all partners. The preferred return is paid next, before the General Partner or Managing Member receives any profit.

Since we released the original version of our Real Estate Investment Analysis software in 1982, our focus has been on pro forma financial analysis of real estate investments and of development properties – projecting the numbers out over time to help users gain a sense of what kind of investment performance they might expect from a particular property or project. And for lo, these many years, our customers (and from time to time, we ourselves) have used the software to help make decisions as to whether or not to buy a property, and at what price and on what terms. Customers have used it to model how things might play out in the worst case, or in the best case, or somewhere in between. They have used it also to compare alternative investment opportunities.