Four Return Metrics You Must Know Before You Invest In A Syndication
- Thousand Doors Group
- Dec 21, 2022
- 4 min read
It is common knowledge that multifamily investments are among the most appealing types of investments available in today's market. This is due to the stability of these investments, which is a direct result of the fundamental need that they fulfill, which is the provision of a place for people to live.
As an investor, you cannot limit yourself to considering only one return statistic for your investments, and investing in multifamily properties is not an exception to this rule. You really must be familiar with the annualized returns, cash on cash returns, internal rate of return, and equity multiple at the very least. You will be able to evaluate performance using these four fundamental measures, which will in turn enable you to make a choice regarding the service. Let's get a better understanding of these terms!
Average Annualized Returns (AAR)
The first criterion to evaluate an investment is its typical annualized return. After adding up all of your revenues from the investment over its lifetime, including cashflow and profit on the sale, divide that figure by the initial capital that was put in. After that, divide THAT total by the total number of years, also known as the holding term, that your money was invested in the transaction. The outcome is the average of the annualized returns of the investment, which is also known by its alternative name, the average annualized returns. For the calculation of AAR, please see the attached formula:
Equity Multiple
The last part of this equation is the Equity Multiple. It is quite easy to understand, as all it does is demonstrate how much your money has grown due to the investments you have made. Because the investor can see how many times their initial investment would grow, this concept is straightforward and easy to grasp. The time worth of money over longer periods of holding is not taken into account, which is a drawback of this method. Below you'll find the formula for calculating this, and it's important to note that the 'Total Cash Distributions' take into account both cash flow distributions and profits simultaneously.
Cash on Cash Return (CoC)
The term "Cash on Cash Return" refers to the ratio of the amount of cash received each year relative to the amount invested initially. The true purpose of CoC is to determine your return ON capital. A cash on cash return of 20% (1 / 5) indicates that it will take 5 years to recoup your initial investment in an asset with that cash on cash return.
The following formula can be used to determine the CoC:
Internal Rate of Return (IRR)
The internal rate of return (IRR) is a figure that determines how much your money is growing each year and takes into account any cash distributions, such as the earnings from a sale or a refinance. It takes into consideration the time value of money, or the difference between how much money is worth right now and how much it will be worth in the future. Receiving the same return on investment at an earlier time is worth more than receiving the same return at a later time, which is why the latter would produce a lower internal rate of return than the former (all things equal).
The "annualized effective compounded return rate" is what is meant by the term "IRR." The interest rate, also known as the discount rate, is the rate at which the Net Present Value (NPV) of all cash flows is equal to zero. This definition comes from textbooks. The internal rate of return (IRR) provides the most accurate method for comparing different investments; yet, it also happens to be the most complicated one. It is a computation that determines the predicted rate of growth on a yearly basis that an investment will provide.
Instead of placing formulae in this post when you are solving for exponents in series, I suggest utilizing a spreadsheet application such as Excel, Google Sheets, or one of the many others available.
In Conclusion
Because the usefulness of each return metric is constrained by certain factors, it is impossible to focus on a single return metric alone. If an investor is only considering one type of return, there is a risk that they will miss an important aspect of the investment. When evaluating an offering, it is highly recommended that an investor should take a number of different return metrics into consideration. It is important to take into account the investment's risk profile before moving forward with the business plan. It is essential to keep in mind that the returns are impacted by the investment strategy that you choose. In general, you would anticipate something with a higher level of risk to result in a greater level of return.
WE'RE HONORED TO BE IN BUSINESS WITH YOU
Building wealth doesn’t always require you to do all the work you normally would as an independent real estate owner/investor. You can also accomplish the same goal by taking advantage of a syndicated real estate project.
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