I’ve been working with a client recently who is about to increase the return on his equity from about 5% to about 28% in one move. But what the heck does that really mean? I’m not talking cash-on-cash. I’m not talking cap rate. I’m talking about IRR, or an Internal Rate of Return.

What is an IRR?
There are a number of definitions that you can look up and get confused with.

The discount rate that equates the net present value (NPV) of an investment’s cash inflows with its cash outflows (See Methodology) - or:
Internal Rate of Return (IRR): The theorem of internal rate of return is, in effect, compounding interest in reverse, or discounting. In contemplating a current investment with a proposed investment, IRR is a most efficient evaluation. The rate of return on a proposed investment should be equal to the present value of all future benefits, including revenues, as well as the gross costs associated with the (current) property investment. IRR is important in planning capital outlays, as well as evaluating rental real estate investments.

I prefer the way my CCIM Instructor explained it which is “It is the total return on every dollar for all the time that the dollar is in an investment”.

When you’ve owned a property for a long time and you have a lot of equity, and you paid so little that depreciation isn’t helping you out too much, and the property has appreciated significantly - most of the time you are getting a pretty terrible return on your equity.

I’ve been working with one particular investor since last August who has benefited tremendously from appreciation and the cash-flow from his 24 unit brick multifamily. He acquired these contiguous units over a period of about 5 years a number of years ago. Today he only owes about $500,000 on the property but it is worth about $2,400,000. The depreciation he’s taking is insignificant. When we plugged his numbers into our spreadsheet to calculate his return we found that the IRR on his equity, starting today looking out 5 years, is only about 5.8% - not too impressive. So what we’re doing is making one move that will take him from his projected 5.8% to better than 28%. All we’re doing is moving his equity around. Virtually no cash is coming out of his pocket.

The difference that this move will make to his bottom line over a five year period is well over $600,000. After this what he’ll do is liquidate and then exchange all of his equity into something more passive so he can “retire” (really he’ll just be upgrading again). This is planning. He’s not just going to hold on and hope for something. He hasn’t stuck his head in the sand with hopes of retiring some day. He’s making calculated moves based on solid fundamentals and MATH that will result in serious wealth building.

Too often I see guys (and ladies) who bought at the right time and now sit there frozen, not sure what to do, with under-performing equity and often an under-performing property. Don’t leave this kind of money on the table. Take a hard realistic look at what you have, what it’s doing and what it could do. If you don’t have the skills consult with a professional. If you’re sitting on better than 60 percent equity in your property, you are probably robbing yourself of returns, and returns are why you’re in this thing anyway - right?