Trying to understand what makes a real estate investment “good” can be confusing, for new and seasoned investors alike. Below we breakdown some of the most common metrics that investors must understand when assessing the potential returns of a real estate syndication.
Internal Rate of Return (IRR)
IRR is a metric used to calculate the total rate of return of an investment over a specified period of time. It takes into account the initial investment, cash flows, and the timing of those cash flows. A higher IRR indicates a more profitable investment, and it is often used by real estate investors to compare different investment opportunities.
Average Annual Return (AAR)
AAR is a metric used to calculate the average yearly return generated by an investment over a specific period. It provides a simplified measure of the investment's performance by dividing the total return by the number of years in the holding period. AAR is useful for comparing investments with different holding periods and provides a straightforward assessment of the average annual return without considering the timing of cash flows.
IRR vs. AAR
The main difference between IRR and AAR is that IRR considers the timing and magnitude of cash flows, resulting in a more comprehensive measure of return. It accounts for the time value of money and provides a single percentage figure representing the annualized rate of return. In contrast, AAR provides a simple average annual return without considering the time value of money or the specific timing of cash flows. While IRR is often considered a more robust metric for evaluating investments, AAR can provide a quick and straightforward way to compare investments with different holding periods.
Cash on Cash Return (CoC)
CoC is a financial metric used in real estate investing to measure the annual return on the actual cash invested in a property. It is calculated by dividing the annual pre-tax cash flow generated by the property by the total amount of cash invested, typically represented as a percentage. Cash on Cash Return provides investors with an indication of the cash flow generated relative to the initial cash investment and is a useful tool for evaluating the profitability of a real estate investment.
Equity Multiple (EM)
Equity Multiple is a financial metric used in real estate investing to measure the potential return on equity investment in a property. It represents the ratio of total cash distributions (including both operating cash flow and proceeds from the sale) to the initial equity investment. The Equity Multiple provides investors with an understanding of how much they can potentially earn relative to their initial investment
Preferred Return (Pref)
Preferred Return, also known as "pref" or "preferred yield," is a concept in real estate investing that refers to a predetermined rate of return that certain investors receive before other investors can participate in the profits. It is typically stated as an annual percentage and is intended to provide a safeguard for specific investors, such as limited partners or preferred equity holders, to receive a minimum return on their investment before other distributions are made. Preferred Return acts as a form of protection for certain investors and can help align the interests of different stakeholders in a real estate investment.
Unlevered Yield on Cost (UYOC)
Unlevered Yield on Cost in real estate investing is a metric used to measure the expected annual return generated by an investment property relative to its initial cost or investment basis. It is calculated by dividing the net operating income (NOI) of the property by the total cost of acquiring and developing the property, expressed as a percentage. Unlevered Yield on Cost allows investors to assess the property's profitability on a standalone basis, without considering the impact of financing or leverage, and helps in comparing different investment opportunities based on their income-generating potential.
LP/GP Split
LP/GP split, short for Limited Partner/General Partner split, is a common term used in real estate investing to describe the distribution of profits between limited partners (LPs) and general partners (GPs) in a partnership or syndication structure. The LP/GP split determines how the profits generated by the investment property or project are shared between the two parties.
In a typical LP/GP split, the limited partners, who provide the majority of the investment capital, receive a predetermined percentage of the profits. The general partners, who are responsible for managing the investment and often contribute their expertise and operational efforts, receive a separate percentage. The split can vary depending on the specific terms of the partnership agreement but is commonly structured with the LPs receiving a larger portion of the profits, while the GPs receive a smaller percentage but may also have additional incentives tied to performance or achieving certain milestones.
The LP/GP split is an important aspect of real estate investment partnerships as it determines how the financial returns are allocated among the different parties involved. It is typically outlined in the partnership agreement or operating agreement and helps define the financial incentives and responsibilities of both the LPs and GPs in the investment venture.