Home
Investing Blog
Advertise with Us
Big-Profit Investing
Real Estate Books
Market Watch
Book Reviews
RE Dictionary
Market Data
Real Estate Articles
Mortgage Financing
Investment Strategies
Real Estate Cycle
Investment Analysis
Capitalization Rates
Megatrends
Forex Investing
International Investing
Real Estate News
Shopping Centers
Best Housing Markets
Investment Process
Useful Links
Contact Us

LEVERAGED IRR CALCULATION

A leveraged IRR calculation (or levered IRR) is required when evaluating a real estate investment in which the investor intends to borrow a percentage of the money required to acquire the property under consideration.

A leveraged IRR is the internal rate of return (IRR) of the investment that takes into account the effect of borrowed funds on the investment’s cash flow. If the investor has determined, for whatever reason, that the use of debt (borrowed money) is out of question, there is no need for calculating a leveraged IRR. The IRR, or internal rate of return, the inputs required to calculate it, and many other real estate investment formulas are presented and discussed with examples in the e-book Real Estate Investment Mathematics.

The internal rate of return is defined as the discount rate that renders the present value of all cash flows expected to be received over the holding period of the investment equal to the equity contributed by the investor at the time of the purchase.

Update me when site is updated
A leveraged IRR calculation, therefore, uses the discounted cash flow model (DCF) and takes into account, in addition to the cost and revenue items taken into account in an unleveraged IRR analysis, the debt service payments to service the loan over the holding period, as well as the repayment of the remaining loan balance upon the sale of the property. Furthermore, it takes into account any taxable income deductions that the owner may be entitled due to interest payments for the loan.

One of the significant unknowns in the leveraged IRR (and the unleveraged IRR) calculation is the resale price of the property under consideration at the end of the holding period. The most commonly used technique for the estimation of this resale value is the forecast of an exit cap rate which is applied to the net operating income (NOI) of the last year of the holding period. The exact formula applied is:

Terminal Value = NOI/Exit Cap Rate

Usually the assumed exit or terminal cap rate is higher than the entry cap rate in order to reflect the uncertainty of future cash flows. The entry or going-in cap rate is calculated as the ratio of acquisition price over the property’s actual NOI at the time of the purchase.

The correct calculation of the expected IRR under reasonable assumptions is of critical importance for making successful real estate investments. The calculation of the IRR over a holding period is not an easy task, especially for multi-tenant properties, as it is predicated on the correct calculation of expected cash flow for each year taking into account all relevant revenues and expenses. In this sense it requires lots of number crunching. For this reason there are several real estate investment analysis software programs that can make this task much easier and more automated and can help avoid mistakes.


Problems of Leveraged IRR Calculation

One of the potentially problematic assumptions of the leveraged IRR calculation is the reinvestment assumption. In other words, the leveraged IRR calculation formula incorporates the assumption that all positive cash flows in any period are reinvested at the same rate as the calculated IRR. For example, an estimated IRR of 150% implies the expectation that all positive cash flows received at any period will be re-invested immediately at a rate of return of 150%. However, this assumption maybe very unrealistic if the investor does not have immediately available investment vehicles that will be providing a 150% return upon investment of the money. If the actual reinvestment rate of received cash flow is considerably lower then the true return of the investment will be considerably lower.

Another potential problem of the leveraged IRR calculation is the multiple-solutions problem. This problem is more likely to appear when the income stream that is used for the calculation of the IRR has sign reversals, that is, cash flow switches from positive to negative and vice versa. Greer and Farrell (1992) suggest that in such a case there may be as many IRR solutions as the number of sign reversals.

Modified IRR Calculation

If the investor feels that he/she cannot reinvest all positive cash flows immediately as they are received at an immediately accruing rate of return equal to the esimated IRR then the leveraged IRR calculation needs to use the so called «modified IRR» (MIRR) formula, which takes into account that all positive cash flows are reinvested at a different rate than the IRR of the investment analyzed. The MIRR allows you to enter a different reinvestment rate that is applied to the property's annual cash flow. The rate used is generally a savings rate or a government bond rate. The return estimated using the MIRR formula, more closely reflects reality as it is rarely possible to reinvest the cash flow from a particular project at the same exact rate of return, which is derived using the IRR formula.

The MIRR calculation involves the following three steps:

MIRR Explained With Example!
Download it RISK-FREE
and Get a Free Loan Amortization Spreadsheet!

1. Find the present value of negative cash flows incurred in any year during the course of the investment, discounting them at the annual interest rate that you would pay to cover any negative cash flows incurred during the life of the investment (finance rate).

2. Calculate the future value of positive cash flows incurred in any year during the holding period of the investment, by growing them at the interest rate expected to be earned on cash generated by the investment (Reinvestment Rate). This re-investment rate can be the government bond rate, or another rate depending on each investor’s availability of immediately available investment opportunities.

3. Calculate the average interest rate that grows the adjusted investment as calculated in step 1 into the adjusted amount as calculated in step 2.

The MIRR calculation process, is explained in more detail, including the specific formulas that are used in each of the three steps and via a numerical example, in the e-book "Real Estate Investment Mathematics" by Petros Sivitanides, Ph.D. In addition to the MIRR, the e-book discusses and presents formulas and examples for several other metrics that can be used for the assessment of real estate investment performance.

Search Our Over 500-Page Website!
Custom Search


Related Posts
Capitalization Rate Estimation Techniques
Discounted Cash Flow Model
Types of Mortgage Loans
Using Borrowed Funds to Finance Property Investments
Mortgage Loan Amortization
The Advantages of Mortgage Refinancing
Real Estate Return Measures
Exit Cap Rate
Historical Cap Rates
Cap Rate Cycle
Capitalization Rates and Interest Rates
Capitalization Rate Data Sources
Capitalization Rate Influences

Search Our Over 500-Page Website!
Custom Search

Real Estate Investment Mathematics!
Download RISK-FREE all these formulas Now!
Internal Rate of Return(IRR)
The 3 Formulas for Modified IRR (MIRR)/Financial Management Rate of Return (FMRR)
Potential Gross Income Multiplier (PGIM)
Potential Gross Income
Effective Gross Income Multiplier
Effective Gross Income
Net Income Multiplier
Net Operating Income
Overall Capitalization Rate/Income Return
Capitalization Factor
Band-of-Investment Formula for Estimating a Market/Required Capitalization Rate
Theoretical-Approach Formula for Estimating a Market/Required Capitalization Rate
Appreciation Return
Total Return
Return on Total Capital (ROR)
Return on Equity (ROE)/Cash-on-Cash Return/Equity Dividend Rate
Before Tax Equity Cash Flow (BTECF)
Equity Investment
Loan Amount
Debt Service
Mortgage Constant
Payback Period
Breakeven Occupancy
After Tax Cash Flow (ATCF)
Taxable Income
One-Period IRR
Income Tax Payment in Association with Income Producing Property
Capital Gains
Formula for Cash Flow for Last Period of Analysis
Future Resale Price
Annual Rental Income of Occupied Multi-Tenant Property
Multi-Period Lease Rate Growth Formula with Intertemporally Variable CPI Forecast
Multi-period Lease Rate Growth Formula with Constant CPI Forecast
Present Value (PV)
Net Present Value (NPV)
Profitability Index


Return from Leveraged IRR Calculation to Investment Analysis

We use third-party advertising companies to serve ads when you visit our website. These companies may use information (not including your name, address, email address, or telephone number) about your visits to this and other websites in order to provide advertisements about goods and services of interest to you. If you would like more information about this practice and to know your choices about not having this information used by these companies, click here


footer for leveraged IRR calculation page