I forgot to mention that since you were originaly asking about IRR, that 45% figure is NOT IRR. You don’t see the amort and appreciation benefits until the end, so being that far out in time, that really reduces their effect on IRR, which will be substantially less.

This is a question directed toward all the financial gurus in here…

When looking at an investment in real estate (assume between 5 to 10 year outlook), what is considered a good IRR when comparing to various other investments (non real estate). A lot of the local deals I look at typcically will pan out near 20% (IRR) because principle reduction over that span helps the total return so much. However, on a pure cashflow basis, the basic ROE is practically insignificant. So the bottom line, if I am able to get better than a 20% IRR over the long haul, how would I compare in the invesmtment market compared to what a good stock portfolio is returning?

I appreciate everyone’s help; however, I am merely looking how to compare IRR on a large real estate portfolio versus various other investments, and what is typically considered a good return in comparison.

What you are talking about is leveraged vs. non-leveraged IRR. ON a cash deal, void of appreciation and tax benefits, your IRR would be eqaul to your cashflow. In equities your IRR is equal to your ROI!

Practically speaking, you can’t evaluate real estate that way. There are too many factors that come into play. As I am sure you are aware, there are four ways to make money with RE – Cash flow, equity build up (if leveraged), appreciation, and depreciation.

To acuratly evaluated RE you need to factor in all four. But since we have to make assuptions on the future performance, your evaluation will only be as strong as your assumptions and your ability to influence the performance of the property.

The flaw of IRR is that it assumes that all money stays in the investment at the same rate of return. So, the next level is to take into consideration the reinvestment of proceeds. The prefered measure is MIRR modified internal rate.

Check out a book called What every investor need to know about cash flow.

This is a complicated topic topic to discuss in short with out confussion, but I believe that the book mentioned will help you process.

Without looking it up, my recollection is that the long-time average return for stocks is about 11% for large-cap stocks. (That’s without adjusting for inflation, of course)

So, if you are earning 20%, you are beating that number quite handily.

My simple model for real-estate returns is like this: first you earn 10% cash-on-cash, (or I don’t do the deal). Then, if you have an 80%LTV loan, and it runs for 20 years, you are amortizing 4% (average) per year. Since you only put down 20%, that represents another 4/20=20% (non-cash) return on your cash. So now we’re up to 30% a year. Finally, if you get 3% appreciation in the value of your property due to escalating lease rates, and if cap rates stay the same (that’s a real big IF), then you pick up an additional 3/20=15% (non-cash) return on your cash invested.

So, the total return is 10% + 20% +15% = 45%/year. Of course, only the 10% is current cash flow, the amort and appreciation parts you don’t get to see until you sell or refinance. But, when you reach that point they are just as real as the cash you’ve been getting all along.

And this doesn’t take into account the tax bennies, either. On the other hand, I believe cap rates are likely to increase, and that can really whack your returns. This shouldn’t be ignored, but it’s too late in the evening for further analysis…

I feel like I’m having a conversation with myself here, but I had a chance to run some numbers and wanted to report back on the results.

I put together a spread sheet, with the actual figures for a ten-year period, using a 20-year 80%LTV loan at 6%. If you buy at a 10% cap AND sell and the same cap rate, the IRR will be 27%. The annual returns on your down payment look much higher, like 50 and 60%, but because you don’t collect that as cash until the end, there is no compounding on them, so the IRR is much lower, as I said it would be in my previous message of last night.

Now, where you can get hurt is if the cap rates go up, which they almost certainly will, I believe. Let’s say you didn’t buy very smart, and got in at an 8% cap rate, and when you go to sell cap rates have climbed to 12%. Then your IRR drops to only 14%! (This is the classic “buy when you should be selling, and sell when you should be buying” scenario.) That’s still better than 11% return in stocks, though.

Now, let’s say you buy at 12% and sell at 8% cap rates (we should all be so lucky). Now your IRR jumps to 39%, which just shows how important buying right and selling right are.

OK, I’m not posting any more to this thread until someone replies… I think.