How to measure the profitability of your investments
Profitability is an essential aspect to consider when evaluating investments. On the flip side, risk plays a crucial role: it’s a known fact that higher returns come with higher associated risks, and vice versa. With that said, there are various ways to measure the profitability of your investments. In this article, we will delve into the main methods.
The first distinction to make is between actual and projected returns. In a previous article, we explained the basic difference between estimated and total returns. Here, we will focus on ways to measure actual profitability – the returns that have already been realized, understanding that past returns are not a reliable indicator of future performance.
Total or final returns
This is the basic measure of an investment’s performance: it expresses the gains or losses in relation to the final investment without considering the timeframe. It is akin to the concept of ROI (return on investment), often expressed as cash-on-cash (CoC) in Urbanitae, either as a figure or a percentage. Let’s illustrate this with an example.
In appreciation projects, crowdfunding platforms’ regulations prohibit providing a numerical estimate of expected returns. However, each investor can get an idea of the anticipated return using a simple formula: (Estimated Income – Estimated Costs) / Total Equity. If the expected return is 38%, the result of this operation will be 0.38, and the CoC will be 1.38.
This was the case with the Plaza Norte project, which was returned to Urbanitae investors in December 2022. Despite an estimated total return of 38%, the final return achieved was 50%, net of expenses and fees.
For debt projects, the total return is obtained at the loan’s maturity. For example, in the Cunit project, the final return was 15.1%.
Nominal / gross returns
While these terms are not synonymous, they can be referred to collectively to highlight the essential points. These returns pertain to the investment’s performance without adjusting for external factors such as inflation (nominal return) or taxes (gross return).
Real / net returns
In this case, we are talking about returns that take into account taxes and other costs (net) and inflation (real). Therefore, these metrics offer a more comprehensive picture of investment performance, allowing evaluation of whether the investment compensates for currency devaluation.
Time-weighted return
Time-weighted return considers the duration of the investment, assigning proportional weights to returns in different periods. It is particularly useful when investments have variable cash flows over time. This metric provides a fair perspective on performance throughout the investment’s life.
Money-weighted return
Money-weighted return adjusts time-weighted return to reflect the total amount of money invested in different periods. It is especially relevant when additional investments are made over time (e.g., using the dollar-cost averaging technique). This metric allows assessing the impact of new investments on overall profitability.
In our investor newsletter, we provide the average annualized return of our portfolio. Additionally, we also indicate the money-weighted annual return: this way, we consider the project’s size, or more precisely, Urbanitae’s equity or contribution to each returned project.
Internal rate of return (IRR)
We have saved the most relevant indicator for last, as it expresses profitability considering the investment’s timeframe. It is a way to offer annualized returns, i.e., what you would have gained or lost if the investment had lasted 12 months. Therefore, the internal rate of return (IRR) is very useful for comparing returns between different investment alternatives.
The formula for calculating IRR is somewhat complex. We can think of it as the annual growth rate that an investment is expected to generate. Generally, an investment does not generate the same return every year. It is common at Urbanitae to make partial repayments, which are crucial in determining the IRR of an investment: if the bulk of the capital is repaid before the scheduled term, the total return may be the same, but the IRR will be higher than expected.
We hope this article helps you better evaluate the profitability of your investments and make more informed investment decisions. If real estate crowdfunding seems like an attractive option, Urbanitae welcomes you with open arms.