The bottom line is this: do not choose one investment over another simply because it advertises a higher rate of return.
I’ve been guilty of precisely this mistake on many occasions, and suffice it to say, it’s gotten me into trouble.
In this podcast, I will define the two main types of returns you’ll usually see advertised in real estate deals: Internal Rate of Return (IRR) and Equity Multiple (EM). Both these metrics are important to use when determining if you should invest and how they match your personal goal. I will also discuss the risk and the assumptions of manipulation.
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Now, let’s look at what we discussed in this episode:
- Define Internal Rate of Return (IRR)
- Define Equity Multiple (EM)
- Discuss the Risk
- The Assumptions of Manipulations
- Questions to ask when you are working at your due diligence
Here’s a breakdown of how this episode unfolds…
The Internal Rate of Return (IRR) is the return on investment. This calculation considers when and how much you will get back, considering all the variables of time, value, and money.
Equity Multiple (EM) is the cumulative distributive return. This is the total amount returned to you over the life of the investment, divided by the amount you originally invested.
Risk can be summed up with this simple question: what are the expected return’s chances to become a reality? The truth is this, the higher the advertised rate of return; the more risk is likely associated with the deal. Well, that’s what you should probably initially assume and look for why the deal makes sense.
You’ll be presented with several metrics whenever you see a pro forma or deck (the investment proposal). Two of the metrics you’ll see are the equity multiple and the internal rate of return.
Peter closes this podcast by sharing his own investing experience before understanding the value of due diligence. Making an intelligent decision beyond what the advertised deals are demands that you do your research:
- Who is running the deal?
- Who are the sponsors that are running the business plan?
- How are they making and manipulating their numbers?
- Do they tend to be conservative or aggressive?
- What is their track record?
- Ask them what have you predicted in the past and what have you ultimately gotten for your investors on these deals?
- Does this deal fit your personal investment goals?
The bottom line here is that you will be presented with different metrics for the potential return on your investment. Sponsors can easily manipulate the metrics to appear better than they are.
We want to hear from you….
What is your story of studying the metrics to make a well-informed investment decision?
Leave a comment below!
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