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What is Internal Rate of Return (IRR)?

In commercial real estate, it’s smart to think ahead and keep a close eye on the numbers.

As a commercial broker with more than two decades in the ring, I’ve continued to rely on a variety of metrics, including Internal Rate of Return, or IRR, to ensure my investments are sound.

IRR stands strong in its ability to identify the value of an investment over time. In essence, it quantifies the yield you’ll achieve after you invest in a property after an approximate ten year period — a metric used based on the average holding period of about seven to ten years.

The calculation accounts for the income generated by the property with expenses, or the Net Operating Income (NOI), and assumes you’ll sell the property based on future income on the tenth year.

calculating IRR

To calculate the IRR, you’ll need to identify expected cash flows for each year, accounting for outflows in the first year. To calculate cash flows, or the Effective Gross Income (EGI), you must subtract potential gross income from vacancy rates and identify your NOI.

Once you’ve identified assumed income achieved for each year, you should be able to see a steady growth. Ultimately, you should achieve an approximate 1 to 5 percent assumed growth rate per year.

Now that you have calculated the expected NOI through year 10, you are in the green to select a capitalization rate, or a cap rate, which is the ratio between NOI and the property’s asset value. You’ll want to make the selection for year 11, when you plan to sell the property.

Often, I’ll set the cap rate to about .5 percent higher than the rate in which I purchased the property — so if I purchased the property at a cap rate of 6, I’ll use a 6.5 rate in year 10 and cap the year 11 income to produce reversionary value.

IRR spreadsheet

Software programs like Excel do wonders in making IRR calculations a cinch. Often, IRR’s sit around 15 percent, however they can get higher if you’re refinancing a property or are involved in a development.

So, if you’re an investor looking to gauge the profitability of a future commercial real estate deal, I’d recommend taking a look at IRR.

Commercial Real Estate News for Friday, Jan. 20

Happy Friday! Before you head off to your weekend, read these commercial real estate articles covering projected CMBS issuance, the record number of skyscrapers erected last year and growing rent prices.

Projected CMBS Issuance for 2017 Under $80 Billion

Higher interest rates and more risk retention rules may bring up issuance in 2017. A number of firms have forecast approximately $75 billion in the coming year. The numbers sits between 2016’s $60 billion and 2015’s $90 billion.

More New Multimillion-Dollar Skyscrapers Rose in 2016 Than Any Other Year in History

Nearly 130 commercial buildings reaching over 655 feet or higher were erected in 2016, beating 2015’s record of 114. A whopping 84 percent were built in Asia, which remains the most populated area for skyscrapers.

Rent in December Soars to Highest Growth Since Start of Recession

Limited supply and growing demand pushed rent prices 4% higher in December, the highest rise in rates since the Recession. To learn more about how supply and demand affect the real market, read our piece on the commercial real estate cycle.

Commercial Real Estate News for Tuesday, Jan. 17

In today’s commercial real estate news: an update on the blossoming real estate sector in Asia, marijuana’s link to high lease price rates, and traps for first time investors to avoid.

Capturing Growth in Asia’s Property Management Frontier

A letter on Asia’s commercial real estate market from Michael Lanning, the president of the Institute of Real Estate Management. Asian markets are watching America’s business model closely, hoping to learn from it and adopt the best practices.

Marijuana Interest Driving Real Estate Deals

As marijuana is set to become legalized in Maine on Jan 30, industrial properties are seeing record high lease prices. Entrepreneurs anxious to get in on the budding industry are looking for indoor farming spaces and storefronts.

Property Investing Pitfalls: A No-Fail Plan for First Timers

A handy list of pitfalls many first time commercial real estate investors fall into. In summary, don’t be too emotional, control your eagerness, do your research, and watch your finances. One of our most recent articles offers more tips on how to be a successful first time investor.

Commercial Real Estate News for Monday, Jan. 16

Welcome back!  In today’s commercial real estate news: Trump’s anti-regulatory stance encourages developers, construction firms brace for an influx of infrastructure projects, and the apartment sector begins to cool.

Homebuilders See Profit in Trump Bulldozing Environmental Rules

Developers are optimistic President-elect Trump will slash environmental regulations when he takes office this week. Homeownership is currently at a historic low, a fact many developers blame on the costs associated with meeting regulations. Despite this, nearly two-thirds of Americans say the laws are worth the price.

US Contractors Gearing up for Trump Spending Windfall

Nearly 75% of construction firms plan to hire on more employees in 2017, according to a survey released last week by developer firms. The optimistic outlook is founded on the hope Trump will make his campaign promises a reality by investing billions in American infrastructure.

Rooms to Go: Expect to See Less Apartment Construction in the Coming Months

After years of growth, the apartment sector may finally reach a plateau in 2017. Rising construction costs, a lack of desirable spaces and a labor shortage are all factors contributing to the cooling off.

Commercial Real Estate News for Friday, Jan. 13

Happy Friday! Our commercial real estate news aggregation today covers a forecast for the world’s commercial market in 2017, an analysis of why REITs are struggling in the S&P and coverage of a bill proposed to help Florida’s businesses with their commercial leases.

How Much Longer will Charlotte’s Commercial Real Estate Boom Last?

Kevin Thorpe, global chief economist for Cushman & Wakefield, spent Thursday forecasting the future of Charlotte’s commercial real estate market, as well as the world’s. For the short term, Trump’s tax cuts, combined with a boost to infrastructure projects, should give a boost to the US economy.

REITs Stumble After S&P Debut

REITs have had difficulty gaining momentum since forming their own S&P 500 real estate sector in late August. Acute sensitivity to increasing interest rates may be to blame for the under-performing stocks.

Larry Ahern Files Bill to Provide Commercial Sales Tax Relief

Good news for Florida business owners. State Rep. Larry Ahern proposed a bill to do away with the tax Florida tenants pay on their commercial real estate leases. According to Ahern, the law will affect 300,000 businesses in the first year, with 1 million eventually benefiting.

Commercial Real Estate News for Thursday, Jan. 12

Good afternoon. Today, the commercial real estate news includes the likely growth of industrial properties in 2017, planning for succession in a family business and a new hire at CBRE South Florida.

US Commercial Real Estate Executives Bet Big on Industrial for 2017

Feeling inspired by the incoming Trump administration, commercial real estate executives are bullish about industrial properties in 2017. Other hot sectors included stable, consistent multifamily properties and infrastructure projects.

Six Things Family-Owned Real Estate Firms Should Know About Succession Planning

There’s a lot details that go into the succession planning for a family owned commercial real estate firm. To help you in the long process, NREIonline has laid out how to do it effectively.

CBRE Hires South Florida Market Leader from Related Group

CBRE has hired Arden Karson for the position of senior managing director in its South Florida offices. Originally from Related Group, the nation’s largest condominium developer, Karson will work to strengthen CBRE’s position in the market even further.

Commercial Real Estate News for Wednesday, Jan. 11

Lots of news in the commercial real estate world today. Find out about it all with these four articles detailing CBRE’s acquisition of Floored, the heightened apartment activity in Orange County, the home of George Lucas’ museum, and trends in foreign investments.

CBRE Acquires Floored: Real Estate Tech Poised For A Big 2017

The largest commercial real estate company in the world has acquired a tech start-up that focuses on interactive 3D imaging. It’s likely CBRE will use Floored’s technology to present clients with highly detailed walkthroughs of their proposed projects.

 In 2016, permits for apartments in Orange County were requested at over double the rate they were in 2015. The article goes on to highlight some of the larger apartment projects in the area.

 The Force Is With L.A: Exposition Park Tapped as Home to $1 Billion George Lucas Museum

Los Angeles has been selected over San Francisco and Chicago as the city to host George Lucas’ $1 billion, 275,000-square-foot museum. The project is expected to create thousands of jobs, both in construction and permanently.

Industrial Overtakes Multifamily as Foreign Investors’ Most Preferred Asset Type

Despite the headline, the articles presents a wide overview of foreign investor’s feelings on American commercial real estate. New York and Los Angeles top the list of favorite cities to invest in. Overseas investors are more pessimistic about the future than they were in 2015. And industrial property overtakes Multifamily as their preferred property type.

Commercial Real Estate News for Tuesday, Jan. 10

Good afternoon. Read these three articles on commercial real estate detailing the relations between demographics and apartments, the state of the Denver commercial real estate market, and a medical REIT’s plan for 2017.

How Demographic Changes Have Impacted the Apartment Market and How They Have Not

The real estate crash of ’08 saw a dramatic rise in non-family households, a good deal for apartment owners. However, city demographics point to a handful of other ways occupancy rates may be explained.

Denver Office Market has ‘Cloudy Horizon,’ but Economy ‘Thrives’

Growth in the technology, healthcare and business sectors forecast a strong economy for Denver, but the commercial real estate market may take a while to catch-up. Construction on office space has slowed down considerably while the market absorbs excess supply.

Medical Office REIT Healthcare Trust Expects to be Active in Acquisitions in 2017

Robert Milligan, CFO of Healthcare Trust of America, noted “tremendous tailwinds” in the healthcare sector due to an aging populace and interest in affordable outpatient centers. Healthcare Trust of America made approximately $700 million in acquisitions last year. Milligan predicts the company will continue to acquire assets in burgeoning markets.

Commercial Real Estate News for Monday, Jan. 9

Welcome back! We hope you enjoyed your weekend. To get your week started right, here are two commercial real estate articles on the senior housing market and an update on Jacksonville’s market.

Consider This Before Jumping into the Seniors Housing Market

With 10,000+ Americans turning 65 every day, the housing market looks promising to real estate investors. Those curious in the market should be cautious though of variables like the need for experienced staff and regulatory oversight.

Cushman & Wakefield: Office, Industrial Sectors Post Strong Numbers in 2016

Jacksonville’s commercial real estate market saw big gains in the industrial and office sectors last year. Leased office space hovered around 1.2 million square ft. while the industrial sector saw 4.9 million square ft. of leasing activity

Commercial Real Estate News for Thursday, Jan. 5

We’ve gathered up three commercial real estate articles for you today. Read below to discover more about the developers behind the Macy’s purchase, a $15 million mall renovation and Gov. Cuomo’s plans for Buffalo.

Buyer of Downtown Macy’s has an Eye for Iconic Buildings

The flagship Macy’s building in Minneapolis has been purchased by New York developer 601W Cos. While their plans for the building are still a mystery, they have a history with iconic commercial real estate.

North Alabama Shopping Center to Receive $15M Upgrade

Florence Square, a 226,886-square-foot shopping center in Florence, is set to receive nearly $15 million in upcoming renovations. One old building will be demolished, while two new ones are raised in its place. Tenants already include PetSmart and Academy Sports + Outdoors.

 Demolition Work First Visible Sign of Northland Progress

A Buffalo redevelopment initiative imagined up by Gov. Andrew Cuomo will show its first signs in the coming weeks. A long abandoned manufacturing plant will be torn down to make room for a training facility for those hoping into enter the tech sector.