When it comes to investing in real estate, there are many different metrics used to measure success. While many investors focus on the returns generated by their investments, it can be difficult to know which metrics to use when evaluating your performance.
Three of the most commonly used metrics are ROI, IRR, and ROE, and each has its own benefits and drawbacks. In this article, we’ll take a closer look at each of these metrics to help you decide which is best suited to your investment goals.
Return on Investment (ROI) is one of the most popular metrics used by real estate investors. It measures the profitability of an investment by dividing the profit by the initial investment. This figure is expressed as a percentage, with higher percentages indicating more profitable investments. While ROI is a useful metric for comparing the profitability of different investments, it doesn’t take into account the time value of money or the impact of cash flows. Additionally, it assumes that all cash inflows and outflows are received at the same time, which is not always the case in real estate investing.
Internal Rate of Return (IRR) is a more comprehensive metric that takes into account the time value of money and the impact of cash flows. It measures the annualized effective compounded rate of return that an investment generates over its life. Essentially, IRR tells you the rate at which your investment is growing, taking into account the timing of cash inflows and outflows. While IRR is a more complex metric than ROI, it provides a more comprehensive measure of investment performance. It also allows you to compare investments of different durations and sizes more effectively.
Return on Equity (ROE) is a different metric that focuses on the return generated by the owner’s equity in a property. It’s calculated by dividing the annual net income by the owner’s equity in the property. This metric is particularly useful for measuring long-term investments, where the investor has a significant portion of their own equity in the property. ROE is not always an accurate reflection of investment performance, since the amount of equity an investor has in a property can vary widely.
Each of these metrics has its own set of benefits and drawbacks.
ROI is simpler and more straightforward, making it a good choice for evaluating the profitability of individual investments.
IRR is more complex but provides a more comprehensive measure of investment performance, making it a better choice for evaluating the overall performance of a portfolio.
ROE is useful for long-term investments, but it can be misleading if the investor has borrowed a large amount of money to finance the property.
Ultimately, the metric you should use depends on your investment goals and the type of real estate investments you’re making. By using a combination of all three, you can get a complete picture of your investment performance and make informed decisions about how to allocate your resources.
My expertise as a Commercial Real Estate Specialist is vital to you as an investor, helping you understand how to apply these metrics to both your current holdings as well as your plans for acquiring commercial properties.
Let's Talk! Christy Westphal 562-294-1838