CRE Portfolio Performance: How to Tell If Your Investments Are Doing Well

Written by Mikko Puikkonen

Understanding your CRE portfolio performance is essential for making informed decisions and maximizing returns. Two primary methodologies used to evaluate investment performance are Money-Weighted Return (MWR) and Time-Weighted Return (TWR).

MWR (also known as Internal Rate of Return or IRR) reflects the investor’s actual experience by accounting for the timing and magnitude of cash flows. TWR, on the other hand, measures the compound rate of growth by neutralizing cash flow effects—making it ideal for comparing different investments or managers.

We will have a high-level discussion of definitions, calculations, and advantages of both MWR and TWR – offering a comprehensive framework for assessing real estate investments and ensuring robust performance reporting.

What is Money-Weighted Return (MWR)?

CRE Portfolio Performance Metric #1: Money-Weighted Return

Definition: MWR, also known as the internal rate of return (IRR), calculates the rate of return considering the size and timing of cash flows. It is sensitive to the specific periods when investments and withdrawals occur.

Calculation: Easy to calculate in Excel using IRR or XIRR functions contingent upon the capturing of cash flows that go in and out of the investment.

Advantages:

1. Reflects Actual Investor Experience: MWR accounts for the timing and magnitude of cashflows, providing a realistic measure of the investor’s actual experience. This is particularly useful in real estate investments, where cash flows can be irregular and substantial.
2. Comprehensive Performance Assessment: When considering all cash flows from inception to the present, MWR offers a holistic view of the investment’s performance over time. Often also referred to as since inception IRR or SI IRR if looking at data since acquisition or development.
3. Sensitivity to Cash Flow Timing: MWR is sensitive to the timing of cashflows, making it ideal for investments with significant variations in cash flow

What is Time-Weighted Return (TWR)?

CRE Portfolio Performance Metric #2: Time-Weighted Return

Definition: TWR measures the compound rate of growth of an investment by smoothing out the effects of individual cash flows. It is calculated by dividing the investment period into sub-periods, typically quarters, and calculating the return for each quarter. These quarterly returns are then compounded to find firstly, the overall return for a single year and secondly, can be used to create annualized returns for multiple years as needed.

Calculation: To calculate quarterly return you can use the following formula used by the National Council of Real Estate Investment Fiduciaries (NCREIF) which follows the well- respected Modified-Dietz approach that is used by the investment management industry.

1. Income Return – this tells you how much of the property return is attributable to Net Operating Income (NOI) or the income the property is generating.

NOI / (Beginning Market Value + ½ Capital Improvements – ½ Partial Sales – ⅓ NOI)

2. Appreciation Return – this tells you how much of the property return is attributable to changes in market value net of any capital you have invested in improvements.

(Ending Market Value – Beginning Market Value + Partial Sales – Capital Improvements) / (Beginning Market Value + ½ Capital Improvements – ½ Partial Sales – ⅓ NOI)

TWR for a single year is computed by multiplying the returns of each quarter, which is calculated as follows:

(1+Q1 Return) * (1+Q2 Return) * (1+Q3 Return) * (1+Q4 Return) – 1 = Annual Return

Advantages:

1. Neutralizes Cash Flow Impact: TWR eliminates the effects of cashflows, focusing solely on investment. This makes it ideal for comparing the performance of different investments or managers. You can also use this method and compare your investment performance to an industry standard benchmark such as NCREIF Property Index (NPI)

2. Standardized Comparison: TWR provides a standardized measure for comparing the performance of different portfolios or funds, regardless of the timing and magnitude of cash flows.
3. Manager Performance Evaluation: TWR is particularly useful for evaluating the performance of investment managers, as it isolates the impact of their investment decisions from external cash flow influences.

Conclusion

In performance reporting, both MWR and TWR play crucial roles in evaluating real estate investment performance:

• MWR offers a comprehensive view of the investor’s actual experience by accounting for the timing and magnitude of cashflows, making it ideal for since inception reporting.

• TWR provides a standardized measure for comparing the performance of different investments or managers – neutralizing the impact of cashflows – and focusing on the investment’s growth

By leveraging both methodologies, owners and investors can ensure a robust framework for assessing real estate investments, taking into consideration historical activity and events. This dual approach allows investors to gain a comprehensive understanding of their assets’ value and profitability while facilitating meaningful comparisons across different investments and managers.

At CREx Software, we specialize in providing comprehensive performance reporting services for real estate investments. By leveraging both Money-Weighted Return (MWR) and Time-Weighted Return (TWR) methodologies, we can help real estate owners and investors by creating a robust reporting framework for assessing their portfolios. Our expert consulting services ensure that you will gain a thorough understanding of your assets’ value and profitability while being able to facilitate meaningful comparisons across different investments and managers. With our detailed analysis and knowledge of industry-standard benchmarks, you can make informed decisions to maximize returns and optimize your investment strategy.