How would you calculate the IRR if you block investor's money in a deal?
Let's say that you have a value-add deal and you hold for 4-5 years. You block your co-investors' cash flow until you sell the property or until a capital event occurs, such as a refinancing. How would you calculate the IRR?

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For Example, which of those 2 scenarios is the correct one?

\#1 IRR = 12.69%

y 0 | -100m

y 1 | +1m

y 2 | +3m

y 3 | +8m

y 4 | +147m

 

\#2 IRR = 12.29%

y 0 | -100m

y 1 | +0m

y 2 | +0m

y 3 | +0m

y 4 | +159m

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Obviously, both scenarios have the same total positive CF of 59m. However, in scenario #2 the leveraged IRR produces a lower result than the IRR in scenario #1, since the 0 cash flows are not "reinvested". In reality, the investors can't access the positive cash flows which occur at the end of y1, y2, y3, and they will only receive their share of the cumulated CF when the property sells.

How is it then correct to calculate it? Obviously, the incentive here is to show the higher IRR if you want to get more investors on board, but that's not my point.

Any perspective, logic, experience will be of help.
[{"id": "gol2vb5", "text": "The second scenario is what actually happens so it\u2019s the correct one. Can the cash flows that are held until year five be invested at a safe rate? That would help. Ladder CD\u2019s, for example.", "replies": [], "depth": 1}, {"id": "gol46me", "text": "Irr is a measure of return on investment adjusted to time. What you have presented are entirely possible as scenarios. Typically the only reasons to withhold cash to investors is because holding the cash would make sense as a reserve account for unexpected expenses or the cash can be used to generate a higher irr if reinvested and distributed later.", "replies": [{"id": "goroz6a", "text": "Yes, that's the reason. Rent is paid monthly and debt serviced quarterly, in a monthly cash flow model. Also, TIs and Capex are high, because of the renovation works. But the renovation expenses are not fully financed. Since you're renovating units and changing tenants, you have vacancy and lower cash inflows. In such a scenario you'd have irregular monthly cash flows, sometimes negative, so you'd keep the cash not to run into liquidity problems.\n\nI also liked the withholdings/reserve idea that someone mentioned. Will try to utilize that. \n\nSo, it seems scenario 2 is the logical one here. I'd really like to entertain the property IRR idea which supports scenario #1 but so far I find it difficult to justify.\n\nThanks guys, interesting to read. If any other perspectives, please shoot.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gol4sma", "text": "Depends what/who you are reporting to. If you, the developer, wanted to know what IRR the property generated then you would use scenario #1. If you want to tell your investors what IRR they got on the deal then you would use scenario #2. In scenario #2 you would also want to make sure you deduct any sponsor promote/incentive fee.", "replies": [{"id": "gol70q7", "text": "This.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gol7o6l", "text": "To me, levered cash flows is the equity cash inflows and outflows that the investor realizes. How much money comes out of their account? How much money goes back in? And when? \n\nBecause money is not going back into their account until year 4, then I would use IRR #2. It is a more fair representation of the IRR on **their** investment. \n\nHere is my logic behind this:\n\nIf you were to take CFs and hold for unexpected CapEx, and then distribute the remaining funds back to investors at the sale of the property, there would be the line item \u201cWithholdings\u201d in my model, just above levered cash flows. \n\nWith this property essentially being traded like a stock, I would discount these cash flows to get a NPV of the asset, and then use that number to calculate an ROI (as a part of my pitch). Here, you can take the y1, y2, etc. cash flows into consideration.", "replies": [], "depth": 1}, {"id": "gpi6o3x", "text": "That\u2019s the difference between a gross IRR and a Net IRR.  The Gross IRR is what the deal did (cash in and out of the deal level bank account).  The Net IRR is what the investors contributed and received.  The investors really only care about the Net IRR after promote and fees, but most companies report the gross with the Net buried in a footnote somewhere", "replies": [{"id": "gpi80t0", "text": "Interesting, thanks. I'll look into it", "replies": [], "depth": 2}], "depth": 1}]