Real estate investing is really about wealth creation. Private equity real estate fund managers seek well-positioned assets they can improve and sell. Investors in commercial real estate are also concerned with how long it will take for these buildings to appreciate.
Companies often use the internal rate of return, or “IRR,” and the equity “multiple” to describe the return on investment of their assets.
The IRR
While both the IRR and the multiple evaluate cash flow, the IRR represents the annual percentage rate compounded for each dollar earned throughout the investment term.
This statistic also accounts for the time value of money, which is the notion that a dollar now is worth more than money tomorrow and that future gains become less valuable the longer it takes to collect them. We may anticipate an expected IRR or compute a realized IRR using actual findings.
Many private equity real estate investors utilize IRR to compare the returns of real estate investments to those of stocks and other equity assets. Therefore a project that generates $1 million over five years would have a more significant IRR than one that generates $1 million over ten years.
However, IRR does not give the whole story. The IRR of a $1 million investment that lasts for one month and yields $50,000 is 70%. This is a fantastic short-term gain, but it won’t go very far in transforming $1 million into more meaningful riches. In this case, the equity multiple is 1.05x.
The Double
The equity multiple represents the amount of money an investor receives after a transaction. If a commercial real estate investor invests $1 million and receives $2 million in return, the multiple is 2x.
Knowing the equity multiple reveals the exact effect of an investment on wealth. Over five years, a 15% IRR on $1 million is sufficient to increase the amount to $2 million.
Short-term real estate investments provide a multitude of attractive IRRs for private equity investors. However, pay close attention to the time it took to do this. A three-month IRR of 30 percent results in a total return of just 7.5%. That’s a great deal of time and money with nothing to show. It is artificial riches. Multiples are the result of genuine prosperity.
Real estate is not a liquid investment. Its ultimate potential and return on investment lie in long-term capital gains, not short-term earnings. Investors must comprehend IRRs and multiples as profit-generating assets. This is how they may accumulate fortune that can alter lives.
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