Essential Real Estate Calculation #5: Average Annual Return (AAR)

For investors that aren’t already familiar with Real Estate Syndications, it involves multiple investors pooling their capital together to purchase no-hassle, hands-off investment properties that deliver passive income and appreciation to the investor. For additional details on real estate syndications, we recommend checking out the following blog posts:

• What is a Real Estate Syndication

• Why Investors Love Multi-Family Syndications

• How to Invest In a Real Estate Syndication

One of the keys to selecting a great real estate syndication investment is performing due diligence and detailed analysis on the Sponsor, Market, and the Property. Our team here at Limitless Investing independently reviews every syndication opportunity prior to sharing with our investors to ensure they are only receiving high-quality, pre-vetted opportunities.

With that said, we believe it is important for investors to understand the Essential Real Estate Calculations that are utilized as part of this analysis. In previous posts we reviewed Net Operating Income (NOI), Cap Rate, Internal Rate of Return (IRR) and Equity Multiple. Today we will be exploring the fifth calculation: Average Annual Return (AAR).

What is AAR?

The Average Annual Return (AAR) is a formula used by real estate investors to measure the performance of an investment over a period of time by taking the average of each yearly return over the life of an investment.

Unlike the Internal Rate of Return (IRR), the AAR calculation does not take into account the timing of the cash flows. For this reason, IRR is superior to AAR when evaluating a real estate investment. This is because cash flow today is better than cash flow tomorrow as you are able to re-invest that capital to other return-generating opportunities.

Why is AAR important?

Even though AAR isn’t perfect, it is still a useful calculation when reviewing a potential investment as it allows investors to quickly assess their average return each year that the investment is in their portfolio. This is why it is provided as part of real estate deal alerts (which you can sign up for here!).

How do I calculate AAR?

The calculation for AAR is relatively simple:

AAR = (Return in Year 1 + Return in Year 2 + Return in Year 3 + ... /

Number of Years

For example, let’s say you invest in a real estate syndication that provides with the following profile:

• $50,000 initial investment

• 7% cash flow per year from rental income ($3,500 per year)

• Property sells in year 3 for double the original investment (original $50,000 + $50,000 profit)

This allows us to calculate the following yearly returns:

• Year 1 Return = 7% ($3,500 / $50,000)

• Year 2 Return = 7% ($3,500 / $50,000)

• Year 3 Return = 107% ($53,500 / $50,000)

Then we can easily calculate the AAR:

AAR = (7% + 7% + 107%) / 3

AAR = 40.33%

This essentially means that your $50,000 initial investment would on average produce 40% or $20,000 per year. However, as we can see from the example above, the actual annual cash flow is much lower in Year 1 and 2 due to the large distribution that is realized when the property is sold in Year 3. This is why it is critical to understand this calculation as it allows real estate investors to drill further into the business plan for each individual opportunity.

Conclusion

You are now armed with one of the most essential real estate calculations. If you’d like to explore how no-hassle, hands-off real estate syndications can offer attractive AAR, don’t hesitate to reach out to discuss your investing goals and subscribe to our blog for future content!

If you’re interested in learning more about investing in a real estate syndication, download your free copy of our eBook, Achieving Financial Freedom by Investing in No-Hassle, Hands-Off Real Estate