Private equity real estate sponsors often make projections of the economic performance of the projects using a variety of metrics.

Understanding what they mean is as important as understanding whether they are expected returns at the project level, the investor level and then before fees or after fees.

In each of the following examples, we will be using $100,000 invested by the investor and the actual distributions the investor receives, net of fees. Please note, often sponsors will cite project level returns which have not been discounted for fees or managers carried interest.

Cash Flow

Cash flow is the expected rate of annualized cash flow the project is expected to produce. This target projection however, is often stated as a stabilized number, meaning, once the project has found its footing, typically near the end of the expected hold period.

Targeted Cash Flow Example:

YR 1. 3.0%   YR 2. 4.0%   YR 3. 5.0%   YR 4. 6.0%   YR 5. 7.0%

Stated Targeted Cash Flow 6.5%

Average cash flow:  

IRR

Internal rate of return is a calculation measuring all cash flow, both in and out, using an annualized rate and considering the net present value of money.

IRR Example:

$100,000 invested

Distributions

YR 1. $3,000   YR 2. $4,000   YR 3. $5,000  YR 4. $6,000   YR. 5 $7,000  

Sale in 5th Year, Capital returned plus additional Sales Proceeds

YR 5. $100,000 Return of Capital

YR 5. $73,000 Sales Proceeds

Average distribution per year $20,000 + $20,000 Return of capital

$200,000 total distributions

15.42% IRR.

AAR

A simplified way to look at IRR is through the lens of Average Accounting Rate (Also known as average annualized return). Like IRR, the AAR expresses an annualized rate of return as the name implies, without taking into account the net present value of money.

AAR Example:

$100,000 invested

Distributions

YR 1. $3,000   YR 2. $4,000   YR 3. $5,000  YR 4. $6,000   YR. 5 $7,000  

Sale in 5th Year, Capital returned plus additional Sales Proceeds

YR 5. $100,000 Return of Capital

YR 5. $73,000 Sales Proceeds

Average distribution per year $20,000 + $20,000 Return of capital

$200,000 total distributions.

20% AAR.

Equity Multiple

An equity multiple is a simplified way to quickly summarize the overall return to investor during the expected hold period. A 2.0 X or 2.0 Equity Multiple is a simplified way of stating that the investor is expected to receive 2 times or 2.0X on their original investment over the life of the investment. This is calculated as total distributions divided by total capital invested. It is expressed as a simple multiple and not weighted based on time. 

$100,000 invested, $200,000 distributed

2.0X Equity Multiple

Whether over one year (100% annualized) or 10 years (10% annualized), equity multiple is a simple outcome based measurement not dependent on time. 

Understanding the various ways targeted or projected outcomes are reported by private equity real estate sponsors is crucial for investors to make informed decisions and accurately assess the potential returns on their investments.