You’ve made the decision to make an investment in a private real estate offering, congrats! Now, you’re in receipt of quarterly distributions to your bank account along with all the various reporting that measures your investments’ performance. In this article, we’ll highlight some of the most commonly used valuations metrics to help you understand both what they mean and how you can use them to assess your investments’ performance.
NAV (Net Asset Value):
In real estate investing, NAV is calculated as the estimated value of all assets in a fund (less liabilities) divided by the number of shares or units. It is used to determine the market value of the fund. The fund’s investments in real estate are classified as Level 3 investments, meaning valuations are derived from other valuation methodologies, including pricing models, discounted cash flow models and similar techniques. It is not based on market, exchange, dealer, or broker-traded transactions. Because of this, the NAV of an illiquid investment, like private real estate, is only an estimate of the current market value and may be subject to change.
- Valuation: NAV is used to determine the value of a private real estate fund, which is important for both the investors and the fund managers. It allows investors to see the performance of their investments, and it provides fund managers with a way to assess the value of the portfolio. Typically, Fund Managers report NAV to their investors quarterly in accordance with strict valuation guidelines. This reporting can particularly be important to custodians, who seek quarterly guidance on valuation for their reporting.
- Performance: Investors can use the change in NAV, over time, to evaluate the performance of their investments and make decisions about future investments. Real estate has proven to have low correlation to the public markets, which tend to fluctuate abruptly with macro-economic changes and investor sentiment.
In a private real estate fund, for example, the NAV does not generally fluctuate as dramatically in response to market events. The underlying value of the assets tends to be capital markets driven (such as interest rates), combined with specific property performance metrics.
- Fund Management: NAV is also important for fund managers, as it provides them with a way to monitor the performance of their investments. By tracking the NAV, fund managers can identify any issues that may be affecting the performance of their portfolio and take action to address them. NAV can also be used to determine when assets in the fund have reached their pro-forma targeted valuation and are ready to be exited.
Internal Rate of Return (IRR):
IRR is a metric used to calculate an investment’s return over a specified period. Typically expressed as a percentage, this metric considers all the cash flows of an investment over its lifecycle.
It is important to understand that IRR is a time-weighted calculation, meaning that the timing of the cash flows in relation to when the original investment was made is factored into the calculation. Generally speaking, the earlier that cashflows are received by the investor, the greater the IRR will be. It’s important to note that IRR alone does not measure the risk taken for the return generated.
In real estate investing IRR is a useful measure to evaluate the overall performance of a project, taking into account factors such as property appreciation, rental income, and expenses. IRR can be used in many different contexts, understanding the difference between a completed IRR, estimated IRR and target IRR is essential when using the metric.
- Completed IRR (Internal Rate of Return – Completed Investments): IRR (completed), as one may have assumed, refers to an IRR that is calculated using the cashflows that an investment has already produced, without factoring in any future cashflows.
- Estimated IRR (Internal Rate of Return – Active Investments): Estimated IRR considers all contributions and distributions to date, and incorporates a hypothetical distribution equal to the NAV, as of the reporting date. It is used to help investors review their investments and gain a sense of current performance at a given point in time. It is important to note that past results are not necessarily indicative of future performance.
- Target IRR (Internal Rate or Return – Prior to Investing): Target IRR is simply an estimate of the return a sponsor is targeting to achieve with the investment. This usually takes into consideration assumptions about the growth of the asset by the sponsor.
DPI (Distributions to Paid-In Capital) or Equity Multiple:
For active and completed investments, DPI (the “realization multiple”) is calculated by dividing the sum of all distributions by the sum of all contributions. This can be commonly referred to as an Equity Multiple. It is a useful measure to evaluate the overall performance of a project, considering factors such as property appreciation and rental income. If you invested $1 into a project and received $2 in total returns, your equity multiple would be 2.
DPI = Distributions / Contributions
RVPI (Residual Value to Paid-In Capital):
RVPI is calculated by dividing the residual value (NAV) by the sum of all contributions. Residual Value to Paid-In Capital (RVPI) is useful to measure the residual value of a fund as a multiple of the capital paid in by the investors.
Alone, RVPI is a useful measure for investors in gauging the current value of a fund’s assets relative to the initial investment, while also providing a perspective on how much value remains in the fund in relation to distributions the investor may already have received. RVPI can also be combined with the Distributions to Paid-in Capital (DPI) to assess the Total Value to Paid-in Capital (TVPI) of the fund.
RVPI will change as the residual assets in the fund are valued each quarter. RVPI is also reduced as assets are exited and capital is distributed to investors. A fund’s RVPI will therefore reduce to zero at the end of the fund’s life.
RVPI = Net Asset Value / Contributions
TVPI (Total Value to Paid-In Capital):
Total Value to Paid-In Capital represents the total value of a fund relative to the amount of capital paid into the fund to date. TVPI provides investors with a key metric on the performance of their investment at any point in time. Returns consist of both distributed capital and residual holdings, which provides a way to combine both of these and measure them relative to the initial investment.
The total value of a fund is the sum of realized value (all distributions made to investors to date) plus the unrealized value (residual value of investments) still held by the fund.
TVPI is the sum of DPI and RVPI.
Cash Yield:
Cash on cash yield is computed by dividing the sum of distributions over a period by the equity balance as of the end of the period. The yield is generally calculated using the last calendar quarter distributions, annualized. If the invested equity balance reaches zero, for example after a refinancing event or all Fund capital is returned, the yield is no longer defined.
Conclusion:
Valuation is an important metric in private equity investing. It provides a way to measure the value of an investment fund, assess performance, and assist with the management of the investments as a whole. Knowledge and transparency are key factors in making smart and informed investment decisions.
Charlie Jacques supports the Investor Relations team at MLG Capital, splitting his time between working with investors and seeking advancements and efficiencies in the teams’ internal operations. Charlie has a passion for financial literacy and strives to help each investor fully understand the immense benefits of investing in private real estate. Outside of work, Charlie spends his time exploring the Colorado Rocky Mountains come rain, snow, or sun.
