When lenders take the risk of allocating money to a commercial real estate investment, they will have the question of how much of a return they will be earning on the investment.
There are multiple ways to measure this, but considerable invested capital is the most common and accepted. It is a standard method that works well for calculating the return one can make from the investment.
But if you are unaware of the same, the guide here will provide clear information about MOIC and why it is important in commercial real estate investment.
What is multiple on invested capital?
When creating the financial model for a potential investment, the investors are concerned about multiple things, which can also include the distribution of the holding period of investment cash flow and the dollar amount they will receive on the investment.
There are numerous ways one can use to analyze commercial real estate investment. However, sometimes it will be best to choose the valuation methods that will help you feel confident in the investment.
The asset management team often talks about the internal rate of return, the cash-on-cash return, and the equity multiples. There are multiple metrics for analyzing the communication and the deals with the limited partners.
MOIC is a popular metric that will help institutional investors know about the overall cash flow from the investment property.
This incredibly beneficial asset is used to compare the amount of cash used for the initial investment and the amount received during the holding period.
Check the guide ahead to get precise information about the right way of calculation and other essentials.
The method used for the calculation of MOIC will be relatively simple. The equation will be.
MOIC =Total cash inflows/ total cash outflows
To understand things better, here is an example to help you see how the equation works. Suppose you choose to trust a retail store that has a good investment.
You then acquire the property with a purchase price of $30 million and then hold it for about ten years. Every year the property brings in $2 million in cash flow.
Now at the end of the holding period, the property will be valued at about $50 million. After that, you will have to work with a broker-dealer to sell the property.
In this case, the total outflow of the cash will be the purchase price of $30 million. In comparison, the total inflow will be $70 million. Therefore, it will be calculated in the following way.
$2 million (the annual cash flow) * the holding period will be ten years + $50 million sale price. This will come to $70 million in total cash flow. Now calculate the MOIC. This will come to around 2.33. This means the total cash inflow for a limited part-time will be about 2.33x the initial outlay.
Limitations of MOIC
Just like any other metric which is used for analyzing the return on the investment, MOIC comes with its limitations.
You must know some of the returns on the investment. The metrics will consider the amount of time the investor chooses to hold the property, but MOIC does not consider it.
The above example clearly showed the MOIC of 10 year holding period, which came to around 2.33. Now you need to be careful in comparing the MOIC of 2.33, which is generated over two years. It might result in a better investment that will create the same over ten years.
Another thing that the investors need to stay aware of is if the MOIC is present in net or gross. The gross MOIC values the cash flow before subtracting any management fees. While the net one will include all the cash outlays the limited partners incur.
One must stay aware of the projection made in the MOIC calculation. For instance, in case the future results related to net operating income and cash flow certificate to the project, the MOIC figure that will be presented in the holding period might change. This is because the General partner related to the property will incur the management fees.
Because of all these limitations, MOIC is generally calculated along with various other metrics when analyzing investment funds.
MOIC in private equity real estate
When it comes to the private equity industry, MOIC will be widely used in the general idea of the return on investment for a particular asset or point.
Just like the limitations mentioned above, it will be alongside other metrics to give real estate investors a complete sense of the performance of the equity investment.
The example clearly showed MOIC was calculated by dividing the total cash inflow by the cash outflow. It is the other way to think about the cash inflow in the private equity and realize the value of the assets at a specific point in time.
So if you purchase a property and hold it for ten years before selling, you can calculate the cash inflow as the realized value the property will create. In addition, the realized value will be the amount that can be expected to receive when the property is sold.
In simple words, the total cash outflow of the CRE investment can sometimes be calculated as the realized value, or it can be through the rental income plus the unrealized value, which will then be converted into liquidity in the future when the property is sold.
MOIC vs. IRR
Besides MOIC, various other metrics can be used for the calculation. This includes the internal rate of return. The IRR is the discount rate that will help set down the net present value of all the future cash flows that will equal zero.
It is often used as a proxy for the annual interest rate or rate of return on the projected cash flow series. The formula for IRR is rooted in the concept of the time value of money.
It is the idea that a dollar received today will be worth more in the future time because of its ability to be reinvested at earned interest. Thus, accounting for the responsive IRR formula can be complex. So it can be easier to use an online financial calculator.
A significant difference between IRR and MOIC is that the IRR calculation will take time, while MOIC does not. But, like the example mentioned, it is clearly shown MOIC will require just the cash outflow and inflow.
The relationships indicate a very profitable investment for a short period. But it will prove to be less impressive for a more extended period. Thus, one might need help deciding if they are presented only with the calculated MOIC.
Conversely, IRR will change depending upon the time frame during which the cash flow is received. So if an investor owns a multifamily property that brings in an inflow of $100000 every year, then the IRR will be different for the ten-year holding period compared to the time frame of 5 years holding period.
As a leader, one must pay attention to all the metrics that will help calculate the returns on the investment. In addition, it will help decide if the investment is worth it and if one should provide the money to the borrower.
The methods are mostly used for the limited partners to understand the equity value of the investment and the distribution. It will also help compare the cash initially invested into the deal or fund.
MOIC is helpful in CRE investing because it is easy to calculate and can be compared from one investment to another. But the only downside here is that it does not consider the investment holding period or the cash flow timing.
Thus, it will be beneficial to take your time to understand things better before choosing metrics for the calculation purpose.
When planning to fund the borrower, you must calculate the return you can expect from the investment. However, if you are facing difficulty in any aspect of an investment, then consider trusting Private Capital Investors to get expert support.
They have got a team of certified professionals. They are well aware of the process and can offer you the best support possible. Irrespective of your need, their experts will help you understand things better and guarantee you can maximize the investment opportunity. Thus, the results will be high, and you will enjoy better returns.