IRR mentally/ in head?
Hi everyone 

A common interview question is to estimate IRR in your head. Let’s say you buy an office at 6% income yield and sell at 5% in 5 years and have an LTV of 60%. 

How do you do it? I see some people think in terms of equity multiple and take it from there 

Thanks in advance

SOLVED - see my comment below
[{"id": "fwh3g3g", "text": "You\u2019ll need number of years and beginning and ending LTV as well for this calculation. I would just play around with it in Excel using the XIRR formula with easy numbers and that will help you get an idea of what different returns look like.", "replies": [{"id": "fwh48cz", "text": "What if we say the income is flat at 100? Then you have entry and exit values and a hold period", "replies": [], "depth": 2}], "depth": 1}, {"id": "fwh85qi", "text": "At a $6 NOI, you would have purchased the building for $100. The purchase was funded with $60 of debt and $40 of equity. Now, you sell that same $6 of NOI at a 5% cap, which is $120. When netting out the $60 in debt, you receive $60 in net proceeds. (If you wanted to get more granular, you could add the net cash flow earned from the NOI less interest expense, but you did not provide the interest rate.)\n\nEquity Multiple = 60/40 = 1.5x\n\nIf you assume this was a 1 Year Hold, you could estimate an IRR around 50%. (Assuming a 6% interest rate, you would add another 6% to IRR).\n\nAs someone who works in RE at a high level, I\u2019m not sure this question has ever been verbally asked to me or by me in any interview setting. It certainly has been asked via an Excel Test though.", "replies": [], "depth": 1}, {"id": "fwhrn7r", "text": "I know a back of the envelope / mental trick for levered returns on a loan. You could adapt it for equity but it would have to assume a static cash flow and cap rate.\n\nAssume I write a loan at L+400, 1 pt in and 2 yr term, unlevered return is L+450. Assume you finance it by borrowing at a 75% advance rate at L+250. 75% is 3x leverage. Your return on the levered portion is 200 (L+450 - L+250) * 3 = 600. Add that to your unlevered yield and your levered return is appx L+1050. Other nuances like exit fees, LIBOR floors, etc. And it's not time based so it's an approximation of IRR.\n\nFor equity return, guess you could swap cap rate in for loan coupon, and use your borrowing assumptions where I said financing costs. And just adjust the levered return multiplier to your LTV (60% financing in your example would be 1.5x [60% / 40%]).", "replies": [], "depth": 1}, {"id": "fwhvz5m", "text": "I\u2019m a simpleton and like the back of envelope quick calculation as well. Please correct me if I\u2019m wrong or missing something. Assuming purchase price of $100,000. 6% coupon = $6,000 per year x 5 years = $30,000 in total income. Sold at a 5% Cap rate equals $20,000 in appreciation over 5 years. $30,000 income + $20,000 appreciation = $50,000. $50,000 / 5 years = $10,000 per year. \n\nGross Annual Cash on cash return = $10,000 / $40,000 = 25%\n\nTo drill down more I would need loan interest rate and 5 year amortization schedule if it\u2019s not a interest only loan. \nFeedback?", "replies": [{"id": "fwhycgv", "text": "This is fine for cash on cash, but for IRR we need to convert the EM into an IRR roughly", "replies": [], "depth": 2}], "depth": 1}, {"id": "fwi454e", "text": "What is EM? The context of my reply was based on the need to come up with an IRR quickly in your head. I\u2019m more familiar with Investment Banking and EBITDA. A quick IRR calculation in an interview that requires a amortization, depreciation and recapture tax calculation is beyond my abilities unfortunately. \n\nI\u2019ll keep learning from the more experienced Real Estate Professionals on this thread.\n\nThanks for posting.", "replies": [{"id": "fwi50ia", "text": "Your reply is great, we are just trying to use equity multiple (which you can work out in your head quite easily I suppose) to get a rough IRR (which is geometric and annoying to do without a calculator). I think it works. \nThanks a lot for your time, appreciated!", "replies": [{"id": "fwi54wf", "text": "I also hate calculating anything that is geometric in my head. I\u2019m immediately lost!", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fwi4gho", "text": "I figured it out.\n\nTake an example where you have 100 income day 1 and drive income to 120 over 5 years. Assume 60% LTV and ignore cost of debt. \n\nExit cap 5% Implies entry price of 2000 and exit price of 2400. You have to pay back 1200 debt at exit, which implies net proceeds of 1200.\n\nMy EM (or MoM) is obviously 1.5x (2400-1200 / 800) \n\nNOW -&gt; 1.5^(1/5) is 8.45% which is what you get if you do a quick excel check IGNORING annual income, it\u2019s IRR from capital gain\n\nThis is great and a fast way to rough calc IRR", "replies": [{"id": "fwi6jnh", "text": "mergers and inquisitions has examples in their book for a \"paper LBO\" which is essentially the same thing fyi", "replies": [], "depth": 2}], "depth": 1}]