If an investor is going to take the risk of allocating money to a commercial real estate investment, certainly one of the major questions on their mind is how much of a return they stand to earn on their investment. There are many ways to measure this, but one of the most common, and widely accepted in the private equity industry is known as Multiple on Invested Capital or MOIC for short.
In this article, we are going to discuss MOIC. We will describe what it is, how it is calculated, why it is important in commercial real estate investing. By the end, readers will be able to calculate this important metric as part of their investment due diligence and ongoing monitoring process.
At First National Realty Partners, we specialize in the acquisition and management of grocery store-anchored retail centers and we always calculate potential MOIC as part of our due diligence process. If you are an Accredited Investor and would like to learn more about our current commercial real estate investment opportunities, click here.
Multiple on Invested Capital (MOIC) Definition
When creating the financial model for a potential investment property, investors are concerned with several things, including cash flow, distributions, the holding period of the investment, and the dollar amount received upon exiting the investment. There are numerous ways to analyze a commercial real estate investment, and sometimes it is best to use several valuation methods to feel confident in the investment. Asset management teams often talk about the internal rate of return, the equity multiple, and cash on cash return. There is an additional metric – MOIC – that we use in the private equity world to analyze deals and communicate results to limited partners.
MOIC is a metric that helps institutional investors understand the overall cash flow associated with a particular investment property or fund. Specifically, it is used to compare the amount of cash used for the initial investment with the amount of cash received over the holding period.
Let’s take a look at how MOIC is calculated to get a better understanding of how this metric can help us monitor investment performance.
How to Calculate MOIC
The calculation for MOIC is relatively straightforward using a simple equation:
MOIC = total cash inflows / total cash outflows
Let’s use an example to show how this works in practice.
Suppose we find a retail center that we believe to be a good investment. We acquire the property at a purchase price of $30 million and hold it for ten years. Every year the property generates $2 million in cash flow. At the end of the holding period, the total value of the property is $50 million. We work with a broker-dealer to sell the property.
The total cash outflow in this example is the purchase price of $30 million. The total cash inflow is $70 million, calculated as follows:
$2 million in annual cash flow x 10 year holding period + $50 million sale price = $70 million in total cash inflow
Now that we have the cash inflow and outflow figures, we can calculate the MOIC as follows:
MOIC = $70 million / $30 million = 2.33
This means that the total cash inflow to the limited partner was 2.33x their initial outlay.
MOIC Limitations
Like any metric used to analyze return on investment, MOIC has its limitations.
It’s important to know that some return on investment metrics take into account the amount of time the investment was held, but MOIC does not. In our example above we saw that the MOIC over a 10 year holding period was 2.33. Investors need to be careful when comparing MOIC figures across different investment strategies because an MOIC of 2.33 that is generated over a two year time frame might very well be a better investment than one generated over a 10 year time frame.
Another thing that real estate investors need to be aware of is whether the MOIC that their sponsor is showing them is gross MOIC or net MOIC. Gross MOIC would use cash flows before subtracting management fees, while net MOIC could include cash outlays related to fees incurred by the limited partners.
Investors should also be aware of whether projections are baked into the MOIC calculation. For instance future results related to cash flows and net operating income are difficult to project. So, an MOIC figure presented earlier in the holding period might change as the general partner incurs costs related to property upkeep as well as property management fees.
Because of this limitation, MOIC is usually calculated along with a couple other metrics when analyzing a fund’s investment. Later in this article, we will take a look at how MOIC compares to another commonly used return on investment metric.
MOIC in Private Equity Real Estate
In the private equity industry, MOIC is usually used to get a general idea of what the return on investment is for a particular asset or fund. Because of the limitations mentioned above, it is usually used alongside other metrics to give real estate investors more complete sense for the performance of their equity investment.
In the example we showed earlier, MOIC was calculated by dividing the total cash inflow by the cash outflow. Another way to think about cash inflow in private equity commercial real estate is to think about the realized and unrealized value of the asset at a given point in time. So, if we purchase a property and hold it for 10 years, before selling it we can calculate the cash inflow as the realized value created by the property in addition to the unrealized value that we expect to receive when we sell the property.
In other words, the total cash inflow of the commercial real estate investment is sometimes calculated as the realized value, or cash flow received through rental income, plus unrealized value that will convert to liquidity in the future, usually through the sale of a property.
MOIC vs. IRR
Now we’ll compare MOIC to another commonly used return metric known as internal rate of return, or IRR. A brief explanation of IRR will help to set the stage.
The internal rate of return is the discount rate that sets the net present value (NPV) of all future cash flows equal to zero and it is often used as a proxy for the annual rate of return or interest rate that is earned on a projected series of cash flows.
The formula used to calculate the Internal Rate of Return is rooted in the concept of the “time value of money”, which is the idea that a dollar received today is worth more than a dollar received in a future time period because of its ability to be continually reinvested and earn interest. To account for this concept, the IRR formula can be quite complex so it can be easier to use an online financial calculator. See our article on IRR to learn more.
The major difference between MOIC and IRR is that the IRR calculation takes time into account while MOIC does not. Like we saw above, MOIC is calculated as cash inflow divided by cash outflow. This relationship could indicate a very profitable investment over a short time period but might prove to be less impressive over a longer period. An investor might have difficulty making this determination if they are presented only with the calculated MOIC.
IRR, on the other hand, changes depending on the length of time that cash flows are received. So, if an investor owns a multifamily property that generates $100,000 in cash flow every year, the IRR will differ for a ten year holding period compared to a five year holding period.
Summary of MOIC
Multiple on invested capital is a metric used in private equity investing to help investors, mostly limited partners, understand the cash distributions and equity value of their investment compared to the amount of cash initially invested into the fund or deal. MOIC is useful in commercial real estate investing because it is easy to calculate and can be quickly compared from one investment to another. The downside of MOIC is that it does not take the investment holding period or the timing of cash flows into account whereas other metrics like internal rate of return do.
Interested in Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We utilize our liquidity and decades of experience to find multi-tenanted, world-class investment opportunities for our partners. If you are an Accredited Investor and want to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
