Understanding ‘Net’ versus ‘Annualized’ Returns with Real Estate Investments

Though there are many factors that should be considered when evaluating real estate deals, predicted financial returns are near the top of most investors’ lists.

iFunding recently has begun posting non-annualized (in addition to annualized) forecasted returns, to give our investors more visibility into an equity deal’s potential and the impact of time. With our debt investment opportunities, we are displaying the annualized rate, or APR, which is industry standard. These figures and other investment details can be reviewed when you log into the project area of our site.

Let’s look at how to incorporate these numbers into your deal comparisons. As an example, we’ll consider a home refurbishment whose all in cost is $200,000; projected sale price is $280,000; profit to the investor and developer is split 50/50; and estimated time from funding to sale is 9 months. After that example, you’ll read about the same project, but where the investment is a loan at 10% APR.

Stating returns for equity versus debt.

On equity investments (i.e., sharing of profit or loss), it’s most common to state the return on a non-annualized, or absolute % basis. In the above example, the return to investors is 20% (50% of the $80K profit, divided by the $200K invested). This return is distributed upon sale of the home, that is, after 9 months. If one were to calculate the annualized (12-month) equivalent return rate, it would be 26.7%. That’s determined by taking 12 mo’s divided by 9 mo’s, and multiplying by the 9-month return of 20% to scale it up for a year.

On debt investments (loans), it’s most common to state the return on an annualized basis, or “APR” (annualized percentage return). So, if above our example instead involved lending $200,000 to the project operator for 9 months at a 10% APR, then the actual interested would be 7.5% (that’s 9 mo’s divided by 12 mo’s, then multiplied by 10%). This assumes there are no early repayment fees imposed on the project operator.

Time’s Impact on Return Estimates

Projects can take shorter or longer than expected, due to factors like receipt of building permits, using or not needing the buffer time built into a project plan, or time-to-sale on the market. Here’s a comparison of the impact of time on the above equity and debt examples, with that $200,000 investment.

Net (non-annualized) returns for the above equity and debt examples:

Invest. Type Project Duration: 7 months (ahead of schedule) 9 months
(on schedule)
12 months (behind originally estimated schedule)
Equity 20% non-annualized 20% 20%
Debt 5.8% 7.5% 10%

Now, here are the annualized returns for the above equity and debt examples:

Invest. Type Project Duration: 7 months (ahead of schedule) 9 months
(on schedule)
12 months (behind originally estimated schedule)
Equity 34.3% annualized 26.7% 20%
Debt 10% 10% 10%

Each type of investment, equity or debt, can be right for you as an investor after you consider all the factors, such as security/guarantees backing the capital and total potential return, not to forget reputation of the developer, the financial dynamics of the local and national markets and your own portfolio diversification needs. Just recall to use an apples-to-apples comparison of return rates in the process, either annualized or non-annualized.