Syndication Series #003 – How to Calculate Return on Investment (Equity Multiple, IRR, and CoC)

Before investing in real estate syndications, you need to be able to compare different offerings. Here, we’re going to learn about three of the most common metrics for evaluating real estate investments: (i) Equity Multiple, (ii) Internal Rate of Return, and (iii) Cash-on-Cash Return. By using each of these tools together, you can determine which investment is right for you. 

If you’re just getting started, check out Syndication Series #001: What Is a Real Estate Syndication? 

Equity Multiple — The Big-Picture Return on Investment

The Equity Multiple is as simple as it gets — it measures how much your money grew. 

Imagine you go to Vegas and double your money on a lucky bet. Your Equity Multiple is 2.0x

Let’s say you invest $100,000 in a real estate syndication. Five years later, you get all of your money back plus $87,000 in profit. Here, your Equity Multiple would be 1.87x

Advantages to Equity Multiple 

Equity Multiple is a great metric for two reasons. First, it’s intuitive. Second, it measures the total growth of your wealth, which is the reason you’re investing in the first place. 

Drawbacks to Equity Multiple 

The main problem with using Equity Multiple to calculate your return on investment is that it doesn’t consider the time it takes for your money to grow. 

Is a 1.5x Equity Multiple good? It depends. 

If you receive a 1.5x Equity Multiple over six months, then you found an incredible investment. A 50% gain in half a year is a big win. However, a 1.5x Equity Multiple over the course of 20 years is much less exciting, yielding an annualized return of just 2.05%. To get a true picture of the attractiveness of a real estate investment, you’ll need to break out some more equations. Let’s continue. 

Internal Rate of Return — Using the Time Value of Money for Accuracy 

The next sentence might disturb some readers. The Internal Rate of Return (IRR) is the discount rate that makes the net present value of all cash flows from the investment, across time periods, equal to zero.

Calm down! Take a deep breath! 

In simplified terms, the IRR is the overall rate of return, including both monthly cash flow and capital gains upon sale or refinancing. IRR takes into account the timing of when you contribute and receive cash. 

IRR Examples

IRR can get a little complicated, so it’s best to use some examples. In practice, we don’t use the scary equation above. Microsoft Excel’s XIRR function works just fine. 

Example 1 

This first example represents a low-risk real estate investment. On May 1, 2021, you invest $100,000. Then in each of the next four years, you receive $8,000 in cash distributions. Finally, on the fifth anniversary of your investment, you receive $140,000 back as the property is sold.

Here, the IRR is 12.94%, which you can consider your overall return on investment. Note that your Equity Multiple is 1.72x — you received $172,000 on a $100,000 investment. 

Example 2

This second example shows how the timing of payments can affect IRR. Just like in the first example, you invest $100,000 on May 1, 2021. However, for the next four years, you only receive $1,000 in annual cash flow. Then, at the sale, you receive $168,000. 

Your Equity Multiple is 1.72x — just like the first example. You received $172,000 on a $100,000 investment. However, because of the delayed repayment, your overall rate of return is lower, with an IRR of just 11.62%. IRR knows that money today is worth more than money tomorrow. 

Example 3

This third example shows why IRR isn’t everything. Here, you invest $100,000 on May 1, 2021. Then, one week later, you receive $100,500 as the property is sold. 

Here, the IRR is 29.7%, which is significantly better than the IRR in both of the previous examples. However, Your Equity Multiple is only 1.005x. Many investors would pass on this investment, as the small Equity Multiple wouldn’t justify the hassle of risking $100,000. 

Advantages to IRR

As we’ve seen in the previous examples, IRR is great because it prioritizes the time value of money. All things being equal, you’d rather receive your cash sooner rather than later. 

Drawbacks to IRR 

While IRR is a powerful way to measure your rate of return, it isn’t always the best way to determine your total return. Example 3 above illustrates this problem. An IRR of 20% is great if the investment lasts five years. It’s not nearly as attractive for an investment with a duration of four days. 

Cash-on-Cash Return — Prioritizing Recurring Income 

If you’re looking to invest for recurring income, Cash on Cash Return (CoC) might be your metric of choice. Cash-on-Cash Return is great for analyzing long-term real estate holdings that produce positive cash flow. 

So, let’s say you invest $100,000 and receive $10,000 of cash flow each year thereafter. Your CoC Return would be 10%. Simple enough! For a more detailed discussion, check out my article dedicated to Cash-on-Cash Return

Advantages to CoC

Cash-on-Cash Return is helpful for individuals who rely on their investments for monthly income. Individuals can use CoC Return to compare recurring an opportunity’s monthly income to what they might receive from bonds, dividend stocks, or other real estate investments. 

Drawbacks to CoC

The actual Cash-on-Cash return won’t be as consistent as the equation suggests. Some months will produce above-average cash flow, delighting the investor. On the other hand, you might not receive any cash flow in months where the property requires repairs or capital improvements. 

Additionally, CoC Return doesn’t take into account the profits obtained upon the sale or refinancing of a property. For that, you’ll need to add Equity Multiple and IRR to your arsenal of metrics. 

How to Evaluate Real Estate Investments

For the best results, use all three metrics to determine the right investment for you. If you’re looking for capital appreciation and don’t care much about cash flow, use IRR and Equity Multiple as your primary tools. On the other hand, if recurring “mailbox money” is what you’re after, Cash-on-Cash Return might be your best bet. 

Remember, real estate offers multiple paths to wealth. Everyone’s strategy should be aligned with their goals.

Considering the risk profile of the investment is also crucial. Personally, I’d rather get an 11% IRR on a low-risk, stabilized multifamily property than a 12% IRR on a real estate development project. However, bump the development project’s projected IRR up to 20%, and the investment might be worth the uncertainty. Be thoughtful when building your portfolio and allocating risk. 

Have Questions About Real Estate Syndications? 

If you’re interested in learning more about real estate syndications, feel free to reach out. I’m always happy to talk about real estate! 

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