At a Glance —
- Commercial real estate investors must complete their own due diligence when evaluating investments; part of that analysis includes the review and understanding of the target metrics provided by the operator
- The most important target metrics include cash-on-cash return, multiple of invested capital (MOIC) and internal rate of return (IRR)
- While it is impossible to predict with complete accuracy the property’s future performance, experienced operators will consider a range of scenarios when calculating the target returns to project realistic target performance metrics
Commercial real estate (CRE) investments can offer a lucrative opportunity for those seeking long-term financial stability, wealth protection and growth. However, CRE investors must be diligent in analyzing potential investments to ensure they closely align with their intended investment goals.
A clear understanding of standard metrics together with thorough review of the targets for every potential investment will help investors to ensure that they are making well informed decisions. In this article, we will discuss several important metrics widely used in commercial real estate and how operators project performance.
Each of these metrics help investors assess the projected profitability of an investment and provide a clear understanding of the expected returns.
Cash-on-cash return is the ratio of the property’s annual cash flow to the amount of cash invested. This metric is particularly useful for investors who are financing their investments with borrowed funds.
Cash-on-cash return measures the profitability of the investment based on the cash invested, and it is often used as a quick reference for investors to determine if a property meets their investment goals.
Multiple on Invested Capital (MOIC)
MOIC is another important metric used in commercial real estate investment. MOIC measures the return on the investor’s initial capital investment, taking into account any additional capital contributions or distributions. Essentially, it calculates how much money an investor has made compared to how much they initially put in.
A high MOIC indicates a successful investment, as the investor has earned a significant return on their investment. Investors should consider MOIC when evaluating their commercial real estate investments as this metric provides a clear understanding of the projected profitability of the investment relative to the initial capital investment.
Internal Rate of Return (IRR)
IRR is a more comprehensive metric that considers the time value of money. IRR is the discount rate that makes the present value of the property’s expected cash flows equal to the initial investment.
IRR is a valuable metric for investors looking to compare the profitability of multiple investment opportunities. It provides a clear understanding of the expected return on investment over the investment’s life cycle.
It is important to understand these metrics as well as to understand that targeted returns for a given investment represent the operator’s best estimate. There are many variables in commercial real estate investment and it is impossible to predict with complete accuracy the property’s future performance. An experienced operator will consider a range of scenarios when calculating the target returns, including best-case, base-case, and worst-case scenarios.
Investors should also keep in mind that target returns can vary significantly based on the investment strategy. For example, value-add properties typically have higher target returns than stabilized properties. Value-add properties require more significant investment upfront, but they offer greater potential for appreciation in value over time.
Learn more about the commercial real estate life cycle.
Bottom line —
Commercial real estate investors should perform due diligence when evaluating investments, including review of target metrics provided by the operator — cash-on-cash return, multiple of invested capital (MOIC) and internal rate of return (IRR). While it is impossible to predict a property’s future performance with complete accuracy, experienced operators will consider various scenarios when calculating the target returns to help investors make informed decisions.
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