As the world has made progress, several new concepts, practices and trends have emerged. In the past few years, several people have been able to accumulate loads of wealth. But have you ever wondered what is the reason behind the same? While their work and creativity continue to remain the biggest factors, there’s another vital aspect to it. This aspect is the concept of financial literacy.
You ask any person around the world as to what’s important to generate wealth, the answer would be financially literate. The term financial literacy denotes the awareness of knowing how much money to spend, save and invest. Out of these three, it is the money that is invested which generates the maximum wealth. Investment is what produces the compounding effect & multiples wealth manifold. However, one must be able to make sound investment decisions to avoid losses.
Making Investment Decisions
Several people all around the world invest their money in diverse sectors. Each sector has its own potential and pace of giving returns. One sector that has always remained attractive for investors is the real estate sector. Numerous people around the world have become billionaires by simply becoming real estate tycoons. They have been able to amass huge amounts of wealth in this sector. Despite being one of the oldest investment avenues, it continues to remain profitable till date.
However, investing money is not as simple as it sounds. It doesn’t simply mean showing your interest and giving your money in every project. Investing requires a great deal of knowledge of the stakeholders involved and a careful statistical analysis. One must be able to decipher the plausible threats and opportunities to one’s investment due to the dynamics of the market. Also, it is important to know as to whether the prospective investment opportunity is worthy enough of investment.
Now, you might wonder as to how one can predict such things. Well, there are multiple statistical tools and key indicators that can help you in doing so. Two such indicators are- CoC and IRR. The apartment syndicators who underwrite and the passive investors who invest, all look up to these indicators. Let’s learn in more detail about them and about the consistent IRR vs Cash on Cash battle.
CoC stands for cash-on-cash returns. It denotes the returns on one’s capital invested by establishing a relationship between the initial investment and the cash flow. Thus, it is arrived at by dividing the initial investment with the subsequent cash flow. Here, it is important to note that cash flow is to be taken at its face value per se. The operating expenses and debt service must be deducted from the cash flow in order to arrive at the true figure.
CoC is calculated in two different ways- firstly, by including profits from sale, and secondly, by excluding profits from sale. Both these calculations are vital for determining the profitability of the apartment syndications. While the former predicts overall returns from the whole project, the latter denotes expected average annual returns. The calculation of CoC requires several things. This includes initial equity investment, projected cash flows annually and the projected profits from sale.
CoC calculation depends upon several factors and is subjective in nature. Generally, minimum CoC returns excluding sale must equate with the preferred returns to the Limited Partners.
IRR stands for Internal Rate of Return. It is another vital metric that determines the viability and profitability of a particular investment. IRR takes into consideration what CoC fails to. An important aspect of any investment is the time aspect. We have often heard that ‘time is money’ and it certainly holds true for investments as well. What good is an investment if it delivers a big return percentage but over a long-drawn period of time. Thus, it is important to take the time value of money into consideration.
IRR makes the current value of all cash flows equal to zero. This is done to negate the compounding effect. It helps to determine the true profitability of a project by comparing it with the projected annual growth rate. The calculation of IRR also requires initial equity investment figures, annual cash flows including profits from sale.
The major difference between IRR & CoC is primarily the consideration of time value of money. IRR is a better indicator when it comes to investments that span over more than a year. It is more accurate over a longer period, while the two can be used interchangeably in short investment periods.