Modeling Question: IRR goes down but CoC goes up over time

Question

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.

Full Stack · Accepted Answer

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.

Dr. Rahma Dikhinmahas · Answer

I'll address in order of simplicity/clarity:

IRR often down over time because of compounding.  Simple example, say you invest $100m equity into a deal that generates $50m of cash flow every year.  Lets say zero percent interest to make it easy, so your cash flow goes entirely to reduce net debt.  So first year you now have $150m in equity value for a 50% IRR.  Second year you have $200m equity value but your IRR is only like 41%.  Third year you have 250m equity value but IRR is 35%.

Also, any immediate step-up in value will have more impact in the first year.

babybaboon · Answer

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?

Ozymandia · Answer

"babybaboon"
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.

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Modeling Question: IRR goes down but CoC goes up over time

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Modeling Question: IRR goes down but CoC goes up over time

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