Anyone have input on this? I've built out a model and Levered IRR goes down over time while both Levered CoC and Levered equity multiple go up in the Data Table. I'm staring at this not understanding why, and am curious if this is flat out wrong or if this could actually happen?
I'm looking at it and it doesn't make sense, so I'm a bit stuck. Unfortunately, I can't share the model so I'm asking for more theoretical responses I suppose. Any help is greatly appreciated.
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As you increase your exit year, two things happen: - EBITDA increases so your EV and EqV at exit increases, meaning CoC goes up - Exit dividend is received later which can drive the IRR down if your EBITDA growth is no longer sufficient to offset one more year of discounting at cost of equity
In looking at the data table, both the project level returns for CoC and EM go up, when sensitizing for a longer hold period. But, IRR goes down. Is what I was talking about.
EM is not helpful over a long hold period. What do your trending assumptions looks like? If both EM and CoC are only incrementally increasing in the our years when you had huge jumps in the early years this would make sense.
The reason is that your IRR is heavily reliant on the cash you receive upon disposition of the asset. IRR is a function of return and time. The longer your time period the more years your return is diluted over.
If you buy something for $1MM today and sell it for $2MM next year your IRR is 100% and your EM is 2.0. If you sell that same asset for $4MM in 10 years your IRR is 16% even though your EM is now 4.0.
Since cap rates are in the 5%+/- range the annual cash flow is not going to offset the extra year of hold period.
drunk and bored, watching the presidents cup so I’ll take a stab at this. This happens in my development models all the time. If the majority of your profits are coming from the reversion your irr will most certainly decrease the longer you hold. It’s basic time value of money. The cash on cash should increase during the hold due to inflation. Coc is a single year measurement comparing a specific year’s cf to your initial investment. $100k cash flow in year 2 is a 10% coc on a $1mm investment. IRR measures all years’ cf and the reversion. The further you push out the reversion the lower your irr will be unless you have an insanely high rent growth assumption. If you have to question why your equity multiple increases over time then you might be in the wrong business.
What is the argument to sell the investment at peak IRR vs. holding until year 7 or 10. An IRR investor might want to pull the trigger right at that peak but what would you argue for the project to be holder for longer?
Because no one is only selling on an IRR basis. If I buy a building on May 31 where most of the leases renew on June 1, then I could raise my rents by 1% and say I want sell the property on June 2 and take an annualized 182.5% IRR. No one in their right mind would do that.
But the answer to the question you're trying to ask is that exactly this kind of discussion can become the bone of contention in a fight between a sponsor and an LP, so it's important to be very clear in your operating docs who has rights to demand a sale, or what the buy/sell provisions are.
Awesome. Thanks for this.
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