Could someone explain what internal rate of return, and modified internal rate of return is? I read about it but really didn’t understand what it means exactly.
IRR is an accounting term with all the gobiltygoop that entails. What it means in English is how much does your investment make you if you hold all external factors constant. For example if you have a building #1 that you acquired and financed for $100,000 that gives off cash flow of $1000/year and you borrowed all that money at 10% and building #2 for the same $100,000 that gives a cash flow of $2000/year but you borrowed at 15%. The internal rate of return is a good tool to figure out how much better one investment is over the other one based on the investment itself an not the money to acquire it. I would use IRR to determine if I have efficiencies in running one building versus the other. MIRR means you modify your IRR formula for some reason that you determine is actually relevant to your situation.
I would not look at that at all. In our world when we buy a building we are actually buying 2 things. #1 is a property, #2 is a business. The way we asses the property is by looking at the CAP rate. This is established by other properties like this one in this area. The business is assessed by looking at net operating income. This determines how good a business this building is and takes out acquisition costs like mortgages etc.
IRR stands for internal rate of return. It is really a net present value of your cash flow problem. The IRR is the discount rate that makes the present value of future income streams equal to your inital cash investment in the property (in other words, the present value of the income “nets” out the present value of the initial outflow). The profit on the sale of the property is the last stream of income to include in the calculation.
IRR calculation also assumes that the cash flow each year will be invested at the same interest rate as the discount rate.
One version of MIRR is a similar calculation that allows the annual income to be invested at a different interest rate than the discount rate.
Buy a property buy a $50K property with $10000 down, put another $10000 cash into the property for rehab. Over the next ten years, rent the property and receive a positive cash annual flow of $700, $900, $1000,$1000, $900, $1100, $800, $700, $10, and $300. Near the end of the tenth year, you sell the property for a $15000 profit. Your initial cash outlay was $20K, and over the next ten years you collected $7410 in income and another $15K in sale profit. Even though you averaged $2241 in annual income (including the sale profit) on your $20K investment, your IRR is 1.4%
Cost of the property itself is not a factor in this calculation – only your cash income and outgo during your holding period…