INTERNAL RATE OF RETURN Best
for Planning Purposes
The term "Return on
Investment" is frequently bandied about but
becomes irony when the most popular method for computing it actually
discourages investment. (Why?)
From heavy industry
experience and financial writings we learn that methods of Net Present Value (NPV)
and Internal Rate of Return ("IRR") are preferred for the analysis of
complex cash flows. (think flipping, inflation etc.)
The difficulty of applying
these methods may account for their infrequent use in the building industry.
Of these methods that of Internal Rate of Return is particularly attractive
because it yields a result that can be directly compared to the interest rate
returned by other common investments including bank interest, stocks, bonds etc.
This gives client/investors a clear and familiar "benchmark"
from which a reasoned judgment of qualification and impacts of project
optimization can be made. The basis of qualifying then becomes:
AT EQUAL RISK A
PROJECT IS FINANCIALLY QUALIFIED IF IT'S IRR EXCEEDS THE COST OF CAPITAL AND THE
RATE OF RETURN AVAILABLE FROM OTHER INVESTMENTS PROVIDING PROJECT COST IS WITHIN
had previously created computer code for mine engineering programs that
automated both the computation of Internal Rate of Return and structural steel
design. Programs including
these features have now been in use worldwide for over 20 years.
WINBUILDIT adapts these features
to steel framed commercial buildings but recognized that wild dreams, stiffening
seismic and structural period requirements make some concepts impractical.
The automatic structural design feature screens these out before
determining the structural weight needed to calculate the fabricated erected
cost. The UBC 1997 is the basis.
In the event any member is
over-stressed it is "red lined" and the cause identified and
displayed. After correction steel
and other costs are computed by an RSMeansr Square Foot Costs
compatible relational data base. COST,
REVENUE and INTERNAL RATE OF RETURN are the key final display results.
Client confidence is
always essential. Since the IRR
method reflects the entire life cycle of a building from concept to final sale
the majority of data entries are those the client must dictate.
(They do not include building cost and construction time but include
rental rates, maintenance, interest cost, predicting inflation effects, taxes,
percent of space leased, term of ownership and final sale price)
The writers of
WINBUILDIT recognized this preponderance and its importance to a convincing result
but also knew the short attention span of busy clients.
To counteract that habit WINBUILDIT was contrived to function in "the
time it takes for a coffee break". This
to ensure client presence, confirmation, and input during the entire process. The end result then becomes convincingly the CLIENT'S
The power of this has
been seen before when prospects grab the computer to play their own "what
Using IRR as a measuring stick for business efficiency is found
intriguing. It has instant
appeal to ambitious managers turning the investment decision making
process away from the "used car" mind-set towards core
investment values. Arguments for quality have persuasive support.
Marketers will gain a
sense of what the qualifying IRR is that drives the client.
Envisioning a forward business development plan falls into place.
Absent direct knowledge of what IRR a client has in mind a general
knowledge of investment returns provides a useful benchmark for planning
purposes. Not as jazzy as the fabled crystal ball but fully
Here's Why Capitalization Rate Basis
Articles in the Wall Street Journal
(June 2 and 6, 2007)
suggest that a return, calculated on the widely used capitalization
rate basis, of 5 to 6% is considered acceptable if a "bet" on a
future sale price, "flipping", is obtainable.
Distressed at this "betting" business we investigated further. The "Marketing Handbook for the Design & Construction
address this subject while "The Wall Street Journal Complete Real-Estate
Investing Guidebook" advises "SPREADING YOUR BETS" (p 172).
so many solid mutual funds paying above 9% it's illogical (for non
gamblers) to invest in a new commercial building at 5-6%.
Is it any wonder that most
proposed commercial buildings never get built?