Investment analysis information is critical in assisting the investor in their decision whether to buy a particular investment, and if so, at what price.
Investment analysis provides vitally important tools for assisting investors in evaluating various investment alternatives. The Internet and the advent of various commercial real estate data resources have multiplied the number of sources of information on potential investment properties. Investment analysis provides us a means to measure the performance of various alternatives. And with that measurement we can compare it to other investment properties, or even non-commercial real estate Investments.
Yield for commercial real estate is sometimes referred to as Internal Rate of Return (IRR). The derivation of IRR can be difficult to understand, and the subject of some dispute. Nonetheless, IRR measures the average annual return for the money that remains in the investment.
Another way of describing IRR is that IRR is the discount rate at which the present value of all future cash flows added together, exactly equals the initial investment
Stated differently, IRR is the discount rate where NPV is equal to zero. That if you use IRR as a discount rate to discount back all future cash flows of an investment to the present, then add up those present values, you arrive at a sum that exactly equals your initial investment.
Using a financial calculator, or computer, you can calculate yield or IRR on any commercial real estate investment where the projected cash flows exceed the initial investment.
If you were to invest $100 in a savings account that earns a 5 percent compounded interest rate, you could say that the account “yields” a 5 percent return.
It does so, because your money accumulates a 5 percent compounding return on your investment for all the money that remains in the account in the first year. For instance, your $100 would earn $5 in interest. It does so because you have earned 5 percent, or $5 of interest on the $100 that was in the account.
At the beginning of year two, you have $105 in the account.
For the second year you hold the money in this account, you would earn 5 percent on $105, which would mean you would earn $5.25 interest in the second year, etc.
When you withdraw all of your money from this account, in addition to the accumulated and compounded interest you would get the return of your $100 compounded interest, you would get the return of your $100.
If you purchase a commercial real estate investment, receive cash flows for a number of years, then sell that investment, and receive the proceeds, those cash flows during, and when you sell the property, provide both your return on your investment and the return of your investment.
You can analyze these cash flows discounting them back to the present, in order to calculate the yield or Internal Rate of Return (IRR) that this investment provides.