You may have heard the terms IRR, preferred return and equity multiple when discussing real investment but what do they mean?
Typically, when you invest in a real estate opportunity, you’re not just hoping for appreciation in property value (although that is a common perk!). There are structured ways to evaluate how much you might make and when. These concepts, Internal Rate of Return (IRR), Preferred Return, and Equity Multiple are key in determining how your investment could perform. Let’s break down each one in a way that’s easy to understand.
Internal Rate of Return (IRR)
Think of IRR as a measure of the profitability of your investment over time, not just at a single point. More specifically, the IRR is the annualized rate of return that makes the net present value (NPV) of all cash flows (both inflows and outflows) from the investment equal to zero.
In simpler terms, it tells you the rate at which your money grows on average on a yearly basis throughout the lifecycle of the investment, considering not just how much you receive, but when you receive it.
For example, an IRR of 14% means that, over the lifetime of the investment, you’re earning the equivalent of a 14% return each year.
In real estate, projects with higher projected IRRs are generally more attractive, but they also often come with higher risks. A balanced view of IRR and other factors, like cash flow and exit strategy, helps determine if an investment fits your goals.
Preferred Return (Pref)
The preferred return, or “pref,” is a concept designed to prioritize certain investors when it comes to the distribution of profits. In many real estate deals, investors are provided with a specific return on their investment before the general partners (the managers of the deal) or other classes of investors receive their share of the profits. In simpler terms, it means who gets paid first from profits.
This is what we call the preferred return.
For instance, if the preferred return offered to you as an investor is 8%, it means you will get 8% of your invested capital before any profits are shared with the general partners or other investors. Preferred returns are a way to align incentives between investors and deal sponsors by ensuring that you, the investor, get paid first before the sponsors start to receive their portion of the profits.
This doesn’t mean that 8% is guaranteed, but it sets a hurdle that prioritizes investor payouts and sets a minimum return that they receive before profits start to be shared with the sponsors.
Equity Multiple
The equity multiple gives you a snapshot of how much your investment is expected to grow overall. It represents the total return on your investment, measured as a multiple of your original investment.
Let’s say you invest $100,000 in a project with a projected equity multiple of 2.0x. This means that by the end of the project, you should expect to have $200,000—your initial $100,000 investment plus $100,000 in profit, essentially doubling your money. A 3.0x return would then mean tripling your initial investment. It doesn’t specify how quickly those returns will come, just the total you could expect to recieve by the end of the investment’s term.
While IRR focuses on the rate of return annually, equity multiple is a straightforward way of understanding your total return over the life of the investment. It’s a useful metric to quickly gauge the long-term profitability of a deal and a quick way to determine how much money you make on an investment.
Putting It All Together
So, how do these concepts work together to give you a full picture of your potential returns? The IRR helps you evaluate the efficiency of your investment over time. The preferred return should ensure you receive a certain level of return before others get a share of the profits. And the equity multiple lets you see the total payoff in relation to your initial investment.
When evaluating real estate opportunities, these three metrics help provide a comprehensive view of what you can expect in terms of risk and reward. While each one is useful on its own, together they paint a clearer picture of how your money will work for you.
Remember any future projection is just that, a projection. Just because an opportunity states a projected return doesn’t mean it will be achieved. There are many factors that go into the returns of an investment actually makes so it is always smart to do you due diligence and ask as questions.
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Pref Return to Investors: 8%
IRR: 14.79%
Equity Multiple: 3.04%
Seacoast Sands is a 4 unit complex (with another unit being permitted and the potential to add additional units later) that is currently 100% occupied and rents are roughly 180% HIGHER above San Diego market rate!!!*
*https://www.rent.com/california/san-diego-apartments/rent-trends
**The Subscriber acknowledges that the price of the Securities was set by the Company on the basis of the Company’s internal valuation, and no warranties are made as to value. The Subscriber further acknowledges that future offerings of Securities may be made at lower valuations, with the result that the Subscriber’s investment will bear a lower valuation.
Any valuation of our Company at this stage is difficult to assess. Unlike listed companies that are valued publicly through market-driven stock prices, the valuation of private companies, especially startups, is difficult to assess. As a result, if you invest in this offering, you risk overpaying for your investment.
THIS PRESENTATION INCLUDES OR MAY INCLUDE CERTAIN STATEMENTS, ESTIMATES, AND FORWARD-LOOKING PROJECTIONS WITH RESPECT TO THE ANTICIPATED FUTURE PERFORMANCE OF THE COMPANY. SUCH STATEMENTS, ESTIMATES, AND FORWARD-LOOKING PROJECTIONS REFLECT VARIOUS ASSUMPTIONS OF THE MANAGER THAT MAY OR MAY NOT PROVE TO BE CORRECT OR THAT MAY INVOLVE VARIOUS UNCERTAINTIES. NO REPRESENTATION IS MADE, AND NO ASSURANCE CAN BE GIVEN, THAT THE COMPANY CAN OR WILL ATTAIN THE MANAGER’S PROJECTED RESULTS. ACTUAL RESULTS MAY VARY, PERHAPS MATERIALLY, FROM SUCH PROJECTIONS.