Dec '23 • General discussion
How Apartment Deals Are Analyzed (part 2 of 2)
Step 3: Calculate The 3 Most Important Numbers To Determine If an Apartment Building is a GOOD Deal or NOT
The 3 numbers are:
- Cash on cash return;
- Equity Multiple; and
- Internal Rate of Return
Cash-on-cash return - What It is & Why It's Important
CoC is the annual cashflow you get divided by the investment you made to get that cashflow.
It's basically the YIELD on the capital you've invested. In Part 1, the investment you made is $2M (20% of the "All in" costs), and the cashflow (difference between NOI and debt service) is $140,000/yr.
CoC = $140,000/ $2M = 0.07 or 7%
The YIELD is only one of the 2 profit centers from investing in real estate. The other one is the profit from the sale. And the 2nd metric incorporates that as well.
Equity Multiple - What It Is & Why It's Important
The EM or Equity Multiple is a measure of how much your equity or the investment you've made has grown over time. The usual time frame we look at is 5 years.
An EM of 2x means your equity or investment or capital has DOUBLED. Let's say you invest $1M and then after 5 years, you get $2M. That means your investment made a $1M profit ($2M - $1M).
For our example, the profit from selling the building after 5 years is $1M. Assuming the cashflow is $140K per year over 5 years, the total profit from the cashflow is $700K.
Equity Multiple = ($1M profit from sale + $700K profit from cashflow + $2M investment) divided by the $2M investment
EM = 1.85x.
We aim for deals that give us an EM of 2.5x - minimum for apartments, and an EM of 3x as our minimum for hotels.
This means that this apartment (with an asking price of $9M and it needs a rehab amount of $1M) does not pass our EM metric. Hence, we need to buy it for well below $9M.
The reason why we aim for a 2.5x EM is because we want to give our passive investors an EM of 2x on their capital. If you do the math, a 70/30 LP/GP split (limited partners - the passive investors; general partners - the active investors or the people who do all the work) necessitates a 2.5x project EM so the LPs get 2x on their capital.
IRR or Internal Rate of Return - What It Is & Why It's Important
The IRR is the annualized average rate of return and it factors in the time value of money. The formula is quite complicated and beyond the scope of this post.
A 2x EM over 5 years is roughly around 18% IRR. In our apartment deals, we aim to achieve an IRR of 15-20% for our investors.
We have a spreadsheet that we use in calculating all these numbers - which is our Apartment Analyzer.
Do you like our Apartment Analyzer totally for FREE? Write "ANALYZER" below to get it.
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How Apartment Deals Are Analyzed (part 2 of 2)
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