Commercial real estate (CRE) is one of the most lucrative investment asset class in the real estate landscape which provides investors with high and stable returns with consistent annual cash distributions through long leases tied up with Grade A tenants. Over and above the lease payments, the lessee bears the common area charges.
How are returns generated for investors through CRE?
1. Annual Gross Yields through monthly rent distributions.
2. Capital growth through appreciation- Location is the biggest factor in appreciation. As a neighbourhood evolves, the value climbs and the best commercial properties are always in demand.
Hence an investor would like to receive annual cash flows from the investment and capital appreciation from the asset when investor chooses to exit.
Before investing in CRE, investors should understand the key investment performance metrics for evaluating CRE investments to make informed investment decisions.
1.Annualised returns or Internal rate of return (IRR) – Technically, is the discount rate that makes the net present value of all investment cash flows zero. In simple terms, it is the rate of growth (or CAGR) of every rupee of your investment. It factors the time value of money and is an excellent metric to compare investments with different timing of cash flows to identify the most profitable one. It is calculated through an XIRR formula in excel.
But Annualized Returns (IRR) used independently does not give the full picture, as it has the following drawbacks. It does not take into account the size of the return and also does not factor the risk of an investment due to the timing of cash flows. Take for example below
Opportunity 1
1
2
3
4
5
Principal
Distribution
Exit Value
(10,00,000)
60,000
60,000
60,000
60,000
60,000
13,81,144
Cash Flow
(10,00,000)
60,000
60,000
60,000
60,000
14,41,144
Gross Yield
6%
Annualised Returns (IRR)
12%
Investment Multiple
1.7
Opportunity 2
1
2
3
4
5
Principal
Distribution
Exit Value
(10,00,000)
90,000
90,000
90,000
90,000
90,000
11,90,597
Cash Flow
(10,00,000)
90,000
90,000
90,000
90,000
12,80,957
Gross Yield
9%
Annualised Returns (IRR)
12%
Investment Multiple
1.6
In the above example, both the investments rank at par as they have the same IRR. But upon digging deeper and analyzing financial metrics, one would realize that both opportunities hold different risk profiles. Thus, it is important to look at Cash yield and Investment multiple along with IRR to make your decision.
2. Gross Yield is the annual distribution (cash flows) from a CRE asset and is calculated as annual distributions divided by the principal invested. In this case, Opportunity 1 has a gross yield of 6% and Opportunity 2 of 9%. In-spite of the same IRR, opportunity 2 is a less risky option due to higher annual cash distributions For an investor looking for annual income would prefer opportunity 2 over 1.
3. Another important metric is the Investment multiple to understand how much you’ve earned over your initial principal invested (i.e. size of the return).
Opportunity 1 has a higher multiple of 1.7 x return as a result of high exit value in spite of lower annual cash distributions but Opportunity 2 earns higher stable annual cash flows for the 5-year holding period.
Annualized Return (IRR) allows for an apple-to-apple comparison between opportunities but used in conjunction with financial metrics such as Gross Yield and Investment Multiple conveys the cash flows and risks involved to realize that Annualized Return (IRR).
At Restack, we offer curated Institutional Grade Commercial Real Estate Investments and High Yield debentures with targeted Gross Yields, Annualized Return (IRR) and Investment Multiple stated for each opportunity. For each investment, we provide detailed evaluation on market, asset, title and technical aspects. It’s now your chance to invest in the best.
