REsheets’ final installment of “RESHEETS U”, a step-by-step guide to Commercial Real Estate Analysis, appropriately concludes with Internal Rate of Return.
That’s what it’s all about folks, perspective – measuring and comparing the profitability of your investment with any other investment option. In similar terms, we hope you infinitely more profitable learning with REsheets than any other commercial real estate educational guide. Of course, in terms of financial investment, your learning cost is nothing, so your reward is infinite. But remember there’s value in time (see Time Value of Money), and we’ll continue to emphasize just how important that is.
So here’s the straightforward: an acceptable rate of return must be greater than the cost of capital. Simply, if you’re paying 5% to borrow money, you better be making more than 5% on your return, and much more if you’re adding time and effort!
In terms of Commercial Real Estate, Internal Rate of Return is your best method to both compare properties in terms of their efficiency in making money on your money and knowing your best opportunity to sell a property in terms of its lifespan-efficiency in making money on your money.
Finding the internal rate of return, or the ‘discount rate’ that reflects the present value of all future cash flow as ‘zero’, is often tedious work, due to complicated commercial real estate cash flow structures. Fortunately, we live in a computer age, with tools to quickly capture the known and the unknown (or assumptions) of Commercial Real Estate cash flow.
We of course pride ourselves on our own tools: The Commercial Real Estate Cash Flow Bundle (Seriously, it’s Excel at its prettiest).
However you find your own IRR, remember, it’s the great equalizer in terms of money, and in the business world, that’s a figure you can’t go without.