Internal Rate of Return (IRR) is a financial metric that measures the profitability of an investment over time. To calculate the IRR for a real estate syndication, you’ll need to know the cash flows associated with the investment, including the initial investment and all future cash flows (e.g. rental income, appreciation, sale proceeds, etc.)
Here is a step-by-step process to calculate the IRR of a real estate syndication:
Determine the initial investment: This is the amount of money that is being invested in the syndication, typically from the limited partners.
Determine all future cash flows: This includes all cash inflows (e.g. rental income, appreciation, sale proceeds) and outflows (e.g. operating expenses, debt service, capital expenditures) over the life of the investment.
Determine the holding period: This is the length of time the investment will be held before it is sold or liquidated.
Create a cash flow schedule: This is a table that lists all cash inflows and outflows over the holding period.
Use a financial calculator or spreadsheet software to calculate the IRR: Input the initial investment and all future cash flows into the calculator or spreadsheet, and it will calculate the IRR as a percentage.
Compare the IRR to a benchmark: Compare the IRR to a benchmark such as the cost of capital to determine if the investment is profitable.
It’s important to note that the IRR calculation assumes that all cash flows are reinvested at the IRR rate. Also, IRR doesn’t take into account the timing of cash flows, meaning that it doesn’t consider if cash flows happen at the beginning or end of the investment period.
It’s also important to note that a higher IRR does not necessarily mean a better investment, as the investment’s risk profile, the investor’s preferences, and other factors also play a role in determining the attractiveness of an investment.