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Internal Rate of Return & Equity Multiple

When evaluating a real estate investment, there are two different ratios regarding returns that an investor should consider: the Internal Rate of Return (IRR) and the Equity Multiple (EM).

The IRR is the estimated rate of return on invested capital that is generated, or capable of being generated, from the investment within the ownership period. IRR in its simplest terms is the estimated total interest rate paid to an investor for their initial contribution. IRR calculations do not take into consideration the risk profile of a project or other variables potentially affecting overall return. The principal advantage of using IRR as a performance measure is that it takes into account the time value of money; a dollar today is worth more than a dollar in the future.

The EM is the multiple that the investor expects on its maximum equity invested during the life of the investment. The EM is a ratio that divides the total net profit (plus the maximum amount of equity invested) by the maximum amount of equity invested. The EM of an investment does not take into account when the return is made, and does not reflect the risk profile of the offering or any other variables potentially affecting the project’s return. The principal advantage of using the EM as a performance measure is its usefulness in understanding the amount of money projected to be returned to the investor.

While evaluating these ratios, investors should keep in mind that neither the IRR nor the EM guarantee an investments' performance. However if an investor is most concerned about the best use of their investment over a shorter period of time, then a stronger IRR might be considered. Likewise, if an investor is most concerned about a better long-term return, than a stronger EM might be considered.

 

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