Hey All - I'm having issues wrapping my head around the decrease in IRR from 7% to 1.1% even though I'm dropping hard costs by roughly the same percentage.
Do you think even with this decrease in rents/construction costs the IRR is going to drop that significantly? Or am I missing something?
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What is your exit yield? Your YoC is dropping by c50bps and thus your return from capital growth is falling. Given your EM is 1.09, I imagine this is exactly what's happening. So yes it does make sense with that in mind - of course you've given us very little to go by (hold period, rental growth, cost of debt etc)
If you ever need to sense check something because something feels off, use rule of thumbs.
Your yield / COC is your income return. (for the purposes of this excercise, assume the two are one and the same - in reality I know they're not)
Leveraged COC = yield + (yield - interest) * (debt / equity)
This is your income return for every year of income.
Your capital return is the difference between your yield.
Entry yield / exit yield
If you factor in rental growth multiply the entry yield by (1 + growth) raised to the power of n years
The equity return with leverage is (entry yield - exit yield) / (equity * exit yield)
Add those numbers up and divide by the number of years to get an approximate IRR.
It doesn't work in all instances, but it gives you a very rough idea of where your numbers should land.
Just to add to my comments below.
Remember this ignores a lot of the nuance of the actual deal (development, partial I/O, growth etc) but that doesn't necessarily matter as you're only trying to roughly gauge if your model makes sense.
CoC - ignoring I/O is only for 3 years, assume straight I/O and assumes income starts day 1
4.38% + (4.38%-5.50%) = 3.26%
3.26% * 8 = EM 0.26
Capital Return
4.38 / 5.25% = 83.4% of initial equity
With leverage (4.38% - 5.25%) / (50%*5.25%) + 1 = EM 0.67
0.26 + 0.67 = 0.93
Given your actual EM is 1.09 and the approximation above takes you to 0.93, I'd be fairly happy with the logic the model is telling me.
This is by no means an exact science, but it helps to justify the logic of your model without interrogating every formula in every row.
But I have to ask, why would you develop something for 4.8% only to sell it for 5.25% even in your best case scenario? You're taking all of that development risk and not being paid for it. Is this standard in the States?
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