IRR / cap rate help
Don't know much about CRE so any help would be much appreciated. I am presented with an opportunity to purchase a property for $10,000,000. This is my NOI:
Year 0: -10,000,000 1: $579,799.80 2: $603,415.90 3: $627,864.92 4: $653,174.34 5: $10,679,372.51
What will your IRR be based on a five year hold with the property sold at 7% cap rate?
Plugging in those numbers I get 6% IRR but I don't know what to do for the cap rate. Can anyone help?
6.26%. You seem to have already plugged in the cap rate to your year 5 NOI.
You don't know much about CRE but you are considering purchasing a $10 million property?
I think he means this is a case study-type question he's facing
For that set of cash flows, your IRR is 6.26%, but given the set of cash flows you presented and your question, I think you are trying to figure out if you valued the exit correctly.
You didn't break out sale proceeds from NOI in year 5, but I'm going to assume that because NOI is steadily growing at about 4% a year and you are unfamiliar with RE modeling that you assumed that you would sell the property for 10 million, the same price you purchased it for (this would be wrong).
The correct way to evaluate the exit would be to: cap the NOI of the year after you sell the property (assuming this is a stabilized NOI) using the termination cap rate.
In your example, you would cap year 6 NOI at a 7%. Assuming the same 4% a year growth (because we are all friends here and we all know that NOI's TOTALLY grow perpetually in a straight line...), your year 6 NOI would be approximately $706,550. At a 7% cap, that would equal $10.094 million (which would be your sales price). So your year 5 CF would be the sales price of $10.094 million plus your year 5 NOI.
Edited because I found a mistake in my math.
"because we are all friends here and we all know that NOI's TOTALLY grow perpetually in a straight line"
LOL...
+1, spit out my soda.
If you assumed NOIs grow perpetually in a straight line, your value would be Y6 NOI over 7% - 4% (3%). Gordon growth model...
Do you know what industry forum you're in? This isn't a stock.
The theory behind the Gordon growth model - namely, the time value of money - can be applied to any stream of cash flows.
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