Thoughts on Quarterly vs Annual IRR
Does anybody choose to show investors one or the other? Quarterly IRR will be higher due to the timing of distributions which makes it more accurate, but most groups I see use an annual model.
Why wouldn't groups exclusively use a quarterly model to enhance their IRR?
I may be wrong here, but most firms would probably show distributions in their waterfall- you can show IRR from just the operations level which most companies (I’d imagine do) as it’s more Indicative of the actual deal. Distributions aren’t factored out of IRR as they are the return in “internal rate of return”.
I've had requests, especially from foreign capital of what the quarterly distributions are projected out to be. The hold periods are pretty short, so the difference between 1 distribution at the end of the year vs 4 distributions is a couple hundred basis points on the IRR.
Feels like such a small difference that it wouldn't matter. It also sort of demands that you make quarterly distributions, which is a massive pain in the ass from a logistical standpoint and (in my opinion) can leave assets dangerously illiquid in times of acute crisis. You are sweeping cash four times a year instead of one, which to me quadruples the chances you get caught with your pants down and have to make a capital call
Are quarterly distributions not the norm? For each of the JVs I've been apart of quarterly has always been what is done. There are reserves made to ensure there isn't a liquidity issue as you mentioned though.
I guess it depends! I'm not at a REIT or any giant firm, we're like 30-40 people, but we do annual distributions. Frankly, I think it would be difficult and expensive to have enough staff devoted to putting together quarterly updates and making sure those + $$ get sent out for the dozens of deals we are working on, let alone responding to questions, etc. Easier to just do all of that while doing your forward budgeting, since it's all being discussed anyway. Also people tend to be less chatty about this stuff if you send them updates in mid to late December.
my firm distributed quarterly and calculated IRRs on actual distributions made not cash flows. our pro formas / acquisition model returns were also based on actual projected distributions rather than property cash flows.
I posted a thread about something similar recently (specifically re: ARGUS dump format for models) - the general consensus is that the best/most common approach is to model (or export from Argus) monthly cash flows to be able to get extremely granular, then have a separate tab that rolls up the cash flows to quarterly, annual, etc. depending on your calculation needs. Also gives you flexibility if you work at a firm that syndicates some deals and you happen to raise a vehicle that's going to distribute on a different frequency than your norm.
From what I remember in the thread, most people would roll up to quarterly - quarterly is definitely the norm.
It's funny you say most groups use an annual model, I don't think anybody that responded in that thread worked at shops that used an annual-only model, although for ARGUS dump models that's the norm that I've seen as well.
EDIT: To build on this a bit, if you really want to be the most accurate you can be, realistically your property-level returns should be based on monthly cash flows (since there's nothing to distribute at the property you're just measuring net cash flows), and based on distribution frequency at the investor level.
I do think it's important to reflect actual distributions, it can make a semi-meaningful difference in returns. To illustrate, on a deal I'm working on currently quarterly-based IRR is about half a point higher than annual. Is this going to make or break the deal? No. Does rounding up to the next percentage point look better and make it easier to sell to investors? Yes.
Annual vs Monthly likely depends on which asset class. Depending on the asset, monthly cash flows past Year 1 (say for hotels) are useless and are just typically straight lined anyways as you model annually. I guess if you have a office building 99% leased up you know your future monthly cash flows already.
Agreed for hotels and core multifamily (value add you should really do monthly for timing of your capex requirements and roll to market rents).
For everything else monthly is definitely helpful, especially if talking value add so you can more accurately plan cash timing for major leasing costs, capex, etc - if you just use annual for those things it’s easy to overlook that your 100k sf anchor lease up is in the first month of the year and you can’t actually fund it from that year’s operating CF.
For sure, I model the deals I run on a monthly basis for the first year, then depending on if it's like a reno value-add multifamily or I see significant changes in forecasted rents I will build out further. For the most part, it is only helpful internally, as even institutional groups have requested at most quarterly since that's the way we do our distributions. Argus for office in the past is monthly, because TI/LC is important as well as free rent/down time, but I primarily do multifamily manually, since we are always looking to add things to the property up front even in our core properties.
As we get bigger we may switch to annual, since like Ozy said, it does make IR much easier. Since I only have ~$250M in assets I manage for myself, I can do quarterly.
But I'd be pretty upset if I was your investor and was getting annual distributions, but you were calculating returns quarterly. It has actual ramifications when it comes time to calculate promotes.
That's my point - we distribute quarterly, so IRR should be calculated quarterly. I'm not disagreeing with you. I was pointing out you absolutely should do this if you distribute more frequently than annually because otherwise you're underselling yourself (it was really meant as a response to the people in this thread saying that you're overcomplicating things by calculating quarterly returns and should just run annual).
FWIW my shop has JVs with the big shops that everyone slobbers about on this site and they all distribute quarterly, so model monthly, convert to quarters on another tab, boom done
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