Investing Basics

Financial Metrics: Explained

In order to properly understand the due diligence that Revolution Realty Shares provides, we should establish a basic understanding of the metrics utilized on our platform. All metrics provide unique information and should be used in conjunction with other pertinent information in order to fully grasp all aspects of the investment process.
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  • Internal Rate of Return (IRR)
    • The internal rate of return (IRR) is formally defined as the discount rate of an investment where the net present value is set to zero for all revenue streams. In simpler terms, the IRR is an average rate of return over a specific time period; expressed as a percentage that demonstrates the profitability of the investment over that time period. IRR can be used to predict the performance of a potential investment, or to calculate the realized performance of a completed investment. Real estate investors commonly prefer this metric when predicting the overall performance of a potential investment. IRR utilizes the assumptions of the investment, applying the time value of money to those assumptions to produce the desired prediction or calculation of performance. The time value of money states that a return received now, is worth more than the same return received later; due to inflation, opportunity cost, and risk. Therefore, a return of $100 now would result in a higher IRR value than a return of $100 a year later, when calculating the IRR of the overall investment.
  • Cash-on-Cash Return
    • Cash-on-Cash return, also known as the return on equity, is a relatively simple calculation that expresses the relationship between the targeted pre-tax cash flow, and the initial capital investment as a ratio or percentage. This calculation is determined by subtracting all expenses and debt services (if leveraged) from the gross income, dividing the difference by the initial cash investment, and then multiplying by one hundred to get a percentage. This return metric is extremely common in the world of real estate investment, and employed to measure both investment performance and the return on investment. It can also be used to measure the performance of an investment after a capital event; such as a sale, but is more commonly used with operational cash flow that does not include a capital event. When included in Revolution Realty Shares due diligence, one can assume the cash-on-cash return does not reflect a capital event unless specifically stated.
  • Capitalization Rate
    • Capitalization rate, commonly referred to as the cap rate, is a measure derived by dividing the net operating income (NOI) by the current market value or the purchase price of a commercial real estate property. Capitalization rate is expressed as a percentage. It is important to note that the cap rate does not account for the cost of financing or leveraging a property, as the net operating income is the product of the annual gross income, minus all operating expenses experienced in a year. Examples of this metric include maintenance repairs, property taxes, and management salaries. The cap rate is most commonly used by commercial real estate investors, and provides an investor with the expected unlevered annual rate of return. It also can be used to calculate the time that is needed to earn the purchase price back. For example, the current market value for a commercial property is $1M and the NOI is $80,000. The cap rate is 8% ($80,000/$1,000,000), and if purchased at market value it would take 12.5 years to earn that money back ($1,000,000/$80,000). This metric does not take into consideration potential loss of income (if a tenant were to leave), leverage, or the future changes that will likely happen (rent changes, appreciation, time value of money, etc.). A prudent real estate investor should never use this metric as the sole indicator of an investment property’s strength or value. Accordingly, the cap rate is used by real estate professionals in initial comparisons of different investment properties.
  • Equity Multiple
    • Equity Multiple is the measure of total return relative to initial investment. This metric is calculated by adding up all distributions; in RRS’ case, distributions from regular cash flow during the hold period and from sale or refinance and dividing it by the capital investment. Equity multiple is useful in weighing the potential return on an investment opportunity, or gauging the performance of a completed investment. For example, suppose an investor contributes $100,000 to our platform. In this scenario the regular distributions from cash flow over the course of a 4-year hold period equal $74,000 and the distribution for the sale at the end of the hold period is $106,000. The total return to the investor would be $180,000, and the equity multiple would be 1.8x ($180,000/$100,000). It is important to realize that equity multiple is not dependent on time. A return of $180,000 a year after a $100,000 investment would still yield a 1.8 equity multiple. This is therefore very unalike the resulting IRR rate, that would be dramatically different in the two examples mentioned above.