IRRs NOT Cash ROIs are the true return on your investment. See in the example below your IRR is 18.65% whereas your Cash ROI is only 12.72%
And finally look at the huge difference between leveraging with the banks money and not. The example shows owning for cash and earning 7.61% or leveraging and earning 18.65%. As we say, you’d be crazy not to leverage!
Before buying any property you should be very, very conversant with the three ROIs and calculations described above, taking particular note of what’s excluded as well as what’s included in the calculations.
Again the ROIs to be familiar with are:
1. Net CAP rate return: is the % return on your investment capital if you pay cash for the property. In its simplest form calculating ROI is net income/invested capital. If you pay cash for the property the invested capital is the purchase price, if you borrow from the bank the invested capital is the deposit
2. Cash ROI (cash on cash): calculated as Net Income (net of PITI*) divided by Invested Capital (deposit) . Therefore Cash ROI is a leveraged return using a bank loan.
HOWEVER, contrary to what many investors believe, the IRR is the true rate of return on your investment NOT the Cash ROI.
The IRR shown above is 18.65% whereas the Cash ROI is only 12.72%. This is because the Cash ROI disregards principal or loan repayments which must be included when calculating your true ROIs.
3. Internal Rate of Return (IRR): This is the true return on Investment Capital and is calculated as Net Income less interest payments divided by Investment Capital – see calculations in detail above. At this time, IRRs for most Estero properties are 15-20%
* PITI = deductions for: Principal, Interest,Taxes Insurances (and property management)