Today, I am going to share with you an important finding during my deal analysis last week: not all returns are created equal.
Project sponsors / syndicators often use the following metrics to show you the potential of the investment: average cash-on-cash return, average annualized return, internal rate of return(IRR). Personally, I don’t like average annualized return, which is simply the mean of annualized returns, without considering the time value of the money (today’s $100 is worth more than $100 tomorrow). On the contrary, IRR takes into account the time value, which makes it a very good return measure. But two deals with the same IRR doesn’t mean they are equally suitable for you. You need to understand how much IRR is from the final sale, how much is from improving net operating income (NOI). This sometimes is referred as “IRR partition”.
What about average cash-on-cash return? I’ve seen two ways of calculating average cash-on-cash return by different syndicators. The wrong way is to calculate cash-on-cash returns every year, then take the simple mean. The right way is to sum up all the cash flow income over the investment holding period, then divide it by the initial investment. The wrong way can significantly overstate your cash-on-cash return if there is re-finance in the middle of the holding period. The cash-on-cash return is calculated by dividing by the capital at the beginning of the year. After re-finance, most of your capital is returned to you, therefore, the cash-on-cash seems to be very high, but the actual dollar amount is very low. If you are an investor looking for cash flow instead of betting on appreciation, this investment might not fit your profile.
What I’ve learn from my numerous deal analyses is that what the syndicators tell you are usually true (assuming they are ethical), however these may not be the whole truth. What they don’t tell you is more important. Do not get misled by those numbers. This certainly requires both deep thinking as well as experience.
Invest With Confidence.
Here are some free educational resources:
Video of our Coast-2-Coast educational series on asset allocation during the COVID era: https://www.youtube.com/watch?v=8U0lxAPaf_0&feature=youtu.be
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