Why IRR is so high on a compressed timeline?
Hi everybody, I am currently underwriting a 13 units condo development project that has total length of 15 months from close to sale. 15% return hurdle and 70/30 promote slit. The problem is that the IRR comes out 38% with a 1.65x. If I would adjust the IRR lower, to 23%, multiple comes down to 1.33x.
I googled and read some article that saying with compressed timeline, the IRR might be exceptional high. But I am trying to figure out, if this is the case, how do you guys compare projects with different timeline (eg. 2 year vs. 5 year vs, 10 year)?
How do you guys evaluate a project with higher IRR (above 30%)? Is it better to present this project with higher IRR and higher EM or the opposite just to make it marketable? Is it commonly seen that condo project would have a higher IRR because the timeline is relatively short?
Any related comments or suggestions are appreciated. Thank you!
Are you getting monthly cashflows and increasing them, then selling it? Or is this ground-up development.
I think you might be approaching this wrong. If you are doing a major addition that will increase cash flow in the future you should focus on just the Incremental cost of the project and Incremental NOI. If this is a flip you should look for short-term investors.
This will be a ground up development deal.
The answer is yes. Short holds show big pops in IRR. Investors consider that number, but also look to the multiple. 40% sounds great, but, is a 1.25x worth putting my money to work?
Also, if your hold is 15 months, discount cash flows on a monthly basis. Time value of money is important here.
You only compare short- and long-term projects to one another if they are mutually exclusive (i.e. if doing one project precludes you from doing the other project). Otherwise, a comparison is irrelevant. If they are mutually exclusive projects then you have bigger questions than comparing IRR. Presumably, a developer has a pool of money with very specific investment requirements. That pile of money's investors are assuming some hold period with their money to be used on certain types of projects (e.g. for-sale condos vs apartment rentals to hold).
So, really, in practice, I don't see you ever really comparing a 2-year deal to a 10-year deal. Your 2-year investors are very different than your 10-year investors. It's just not an issue that will come up in normal business.
To your other question about how to present to investors, for short-term deals I tend to focus on the return multiple. "You invest $100,000 and in 2 years you get back $145,000." "Absurdly" high returns--like 30% IRR--can seem "too good to be true".
This. You can't just look at IRRs, especially for short term deals.
The type of investor for a short term deal is generally multiple driven. Long-term deals are generally cash-on-cash driven.
IRRs can be so skewed with leverage, lofty exit assumptions, etc. For development/value add deals, look at basic things like spread between unlevered return and exit cap.
The caveat to this is if you're in the investment advisory business. In many cases, you will have investors looking at deals that aren't necessarily mutually exclusive or even 'comparable' but they will be compared. For example, one of our accounts is willing to invest in everything from 2-3 year opportunistic developments to 10 year+ core deals. In that case, you basically have to at least touch on IRR if you want to compare any type of metric. Obviously, there are risk adjusted expectations between those opportunities, but if you just say 'they aren't comparable' that will not be an acceptable answer in some cases, even though it's the 'correct' one.
This situation is typically dealt with a minimum EM i.e. 1.75x for condominiums and 2.00x for rentals (our minimums, large institutional developer)
IRR is IRRelevant. Cash keeps the lights on.
Math wise IRR is annualized which is why it’s so high in a short time frame.
Dumb question, and @Troll - Aged 18 Years" kind of answered already. But, would all of these responses be the type of analysis/input one would bundle up into an investment summary? From a valuation standpoint, it's one thing to calculate IRR at 30% or [insert valuation metric]. The presentation to investors obviously has to set expectations and steer away from that 30% number they might be frothing at the mouth over (given this example).
How deep/detailed of an analysis do lay out there when when presenting to investors, depending on the deal?
I hate this answer, but it depends on the audience how detailed you get. Some investors want a 70-page offering memorandum while others want--quite literally--a 2 or 3 sentence summary. If you are taking a deal to a wide range of investors I would prepare a detailed prospectus with a really good (clear, concise) executive summary.
One thing that surprised me is that you can't "stereotype" the investor. I've had presentations where everyone in the room was an Asian-American entrepreneur and half the room was ok with executive summary-style presentation while the others wanted to get super in-depth (even pedantic) about every nuance of the deal. If I'm presenting, I like to keep the presentation to
Agreed - I'm a big fan of having a standardized 7-10 page template and then putting a ton of stuff in the appendix. Makes everyone happy.
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