Yield (part 3) Beyond IRR

Yield (Part 3) Beyond IRR

Not many investors go beyond IRR in their analysis. For the cone-heads among us there are more advanced methods. One of these is called the “Financial manager’s rate of return” (FMRR). The problem with IRR is that it assumes all cash flows are reinvested at the same rate as the original investment. For example if the property yields an IRR of 11%, the 1st year’s cash flow is assumed to be invested at that same rate. That probably is not a valid assumption. There may not be enough money from this cash flow to reinvest at that rate.

The FMRR assumes that these cash flows will be placed in a bank account or a CD or some safe liquid investment until enough money is accumulated to re-invest. Hence we have the “safe rate” and the ‘reinvestment rate”. The “safe rate” is usually the amount that one would expect to receive on the smaller liquid investment. Some amount of money is determined to be enough to re-invest. When this much is accumulated at the safe rate, the return on that money is then calculated at the “re-investment rate”. The “re-investment rate” would probably be the average yield on the investor’s other investments.

This calculation could be fairly complicated. I can be done with a calculator or even with a pencil. It is more commonly done with a spreadsheet. Very few investors will be using this measure of yield.

Yield also needs to be adjusted for risk. In domestic investments, the major concerns are market risk and credit risk. There are quite a few other factors to be considered in international investments. They will be the subject of the next blog.


David Segrest is a REALTOR in Charlotte, NC

David S. Segrest, CIPS, CCIM, TRC, CEA
david@segrestrealty.com
http://www.segrestrealty.com
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