In this episode of Agents Building Cashflow, Randal delves into the concept of Internal Rate of Return (IRR) and its importance in evaluating real estate investments. Randal explains how IRR helps in assessing the profitability of potential investments by comparing different properties based on their expected cash flows over time, emphasizing the time value of money. He clarifies that while IRR is a crucial metric, it should not be the sole criterion for decision-making, highlighting its limitations such as ignoring project size, duration, and future costs.
The episode is packed with insights and practical tips, making it a must-listen for real estate agents eager to expand their passive income through smart investments. To gain a deeper understanding and learn more about related metrics like Average Annual Return and Equity Multiple, tune into the next episode on Randal’s channel.
Key takeaways to listen to:
- Analyzing returns by mastering the Internal Rate of Return.
- Comparing profitability across properties effectively.
- Considering the time value of money in investment returns.
- Recognizing the limitations of IRR in real estate assessments.
Resources mentioned in this episode:
If you’re interested in learning more about investment opportunities and multifamily funds, just contact Randal at podcast@agentsbuildingcashflow.com.
To connect with Randal and learn more about passive investing, visit www.ridgelineig.com and follow our social media pages below!
To connect with Randal and learn more about passive investing, visit www.ridgelineig.com and follow our social media pages below!
[00:00:00] If you're a real estate agent earning 200, 000 a year and you want to grow your passive income, this show is for you. Learn secrets other agents use and hear from experts in our field who will guide you on your journey to investing in assets like apartment communities. So you can take your commissions and turn them into cashflow.
[00:00:20] Here's your host, Randall. Let's dive in. All right. Hey, welcome back. Today we're gonna talk about some returns and what the acronyms mean, like IRR. And then the next couple episodes are gonna be just like that, IRR, ARR, and then equity multiple. And why it, and how it pertains to the returns you're looking at when you're looking at some of these offerings that are coming out.
[00:00:39] If you know this stuff, great, it's a Friday episode. It's five minutes long. So first one IRR is internal rate of return. So internal rate of return is a metric used in financial analysis to estimate the profitability of potential investments. So you can look at IRR from 123 Main Street, and then IRR from 124 Main S treet and see which one is going to give you a better [00:01:00] IRR or internal rate of return. The term internal refers to the fact that the calculation excludes external factors such as the risk free rate, inflation, cost of capital, or the actual financial risk of the deal. Okay. So again, the IRR, internal rate of return, basically you're taking into account your cash flows over a given period.
[00:01:17] And so if you take a look, if you invest a hundred thousand dollars into a project in month zero, and then you get a series of cash flows that are coming in. So you're getting a thousand dollars in one, two, three, and then you exit. So it takes into account all your cash flows over this given period of time.
[00:01:34] And it takes into account the time value of money. So a straight like ROI on a deal doesn't actually take into account the time value of money and the IRR does. And so the reason IRR is a good metric to look at is because you can quickly compare it to another property with similar profile or exit return timeline, right?
[00:01:53] So if I put $100,000 into property one today, what is the IRR on that in year five compared to the [00:02:00] IRR on property two, if I put the same amount of money into it in year five, what does that look like? It's not the only metric. It's definitely not the only thing you should look at when you're looking at some of these deals because a deal may have a high IRR because you're exiting in two years,
[00:02:14] compared to the actual dollars returned in a deal. And so you need to take multiple things into account. And that's why we're going to talk about average annual return and the equity multiple as well. So we'll talk about that in the next episode. If you have questions about the IRR there's a ton of information online.
[00:02:30] You can go on. Investopedia has a ton of stuff on it as well. There's a lot of reasons why you should not be using IRR. So like I'm on one right here. So it's a disadvantage of the internal rate of return, is that the method does not consider important factors like project duration, future costs, and size of the project.
[00:02:43] It doesn't take into account the fact that you could reinvest some of those dollars. So it ignores actual dollar value of comparable investments. It doesn't compare the holding periods of like investments, and it does not account for eliminating negative cash flows. It provides no consideration of the reinvestment of positive [00:03:00] cash flows.
[00:03:00] So again, if you're getting these positive cash flows, what happens if you reinvest those and you compound those and, or take those dollars and invest in something else? So it can be limited obviously, but it's an important metric that people look at whenever you're looking at these deals. For large multifamily deals, typically you're looking for at least a 15 percent IRR and 12 percent IRR with a 15 percent AAR and I'll explain why.
[00:03:23] Most of these deals, when you're investing in large syndications or funds, you're trying to double your money in five years, right? So that means that you need to be hitting a 20 percent AAR in order to get there. That is what we'll talk about on the next episode. So until then, if you have any questions, drop me a line, podcast@agentsbuildingcashflow.com, you'll get me there and catch you guys on the next episode. Did you know that 80 percent of the agents we speak with gotten to real estate in order to gain passive income so they could obtain financial freedom and become work optional.
[00:03:47] If you want to stay up to date, the best way is to make sure you're subscribed. So if you haven't done that, go ahead and do it now. We'll catch you on the next episode.