Modified Internal Rate of Return: Predicting Your Investment Profits

How do you know if your real estate venture will make money? You're dealing with a considerable amount of money, and you don't want to waste a single penny. A real estate investment is not something you want to dive into blindly, which is why the modified internal rate of return is so useful.

The modified internal rate of return, or MIRR, is a calculation that gives you an idea of how much your real estate venture will make you. In the end, the modified formula tells you whether the deal is worth it or not.

Before you can understand the MIRR, you need to be familiar with the internal rate of return.

Internal Rate of Return

The internal rate of return, or IRR, is basically the expected profit on a real estate venture. There is a difference between the two figures. Knowing which is which can help you master these somewhat complex formulas. The results of this type of calculation have been used by big companies for years to predict if a project is worth financing.

Basically, this calculation tells you the expected yield of a venture or project. This yield should add to the company's (or investor's) wealth, and is measured against other possible projects. It is also sometimes measured against existing projects. For example, when a corporation is considering several different investments, it may use this calculation to decide which is most profitable.

The IRR Gets Modified

What makes the "modified" rate of return different? This second formula takes into account not only the expected yield, but accounts for the yield after reinvesting in the initial project. This is the goal with commercial real estate ventures; to reinvest some of that profit into the business so that it continues to increase in profits.

The MIRR is a great way to predict how much your possible project will make, but with real estate ventures, it is not always so easy. The first step for any real estate investor is to pay back the property loans that funded the project in the first place. Very few people can start a career in real estate investment without first taking out a hefty loan, and you won't see the profits until afterward.

Advantages of the MIRR
This calculation is a better predictor of how much profit a project will make, because it assumes that the money will be reinvested at the same initial cost. If you work out the same problem using both methods, you will sometimes find that the profit balance comes out positive with the IRR and negative with the MIRR. This is dangerous, because the IRR may be misleading profit-wise.

Basically, the modified calculation is the better of the two because it allows you some flexibility. You can enter whatever amount you deem appropriate. The IRR has a tendency to overstate the amount of money you will make, so the modified internal rate of return is safer to use for long term projects.

Once you know how to use this calculation, you will be able to safely predict whether a particular real estate investment is worth doing or not.