Some Problems of the IRR in Measuring PEI Performance and How to Solve It with the Pure-Investment AIRR
Journal of Performance Measurement, 2018, 22(2) (Winter), 39-50.
15 Pages Posted: 13 Feb 2018 Last revised: 1 Oct 2018
Date Written: February 15, 2018
The internal rate of return is the prominent tool for measuring the performance of real estate asset and investment portfolios. However, it brings about some problems that make it unsatisfactory, such as (i) failing to capturing value added, (ii) being associated with implicit interim values that may signal short positions when, in fact, no short position has been taken on the part of the investor, (iii) generating multiple rates of return. Several authors have proposed substitutive metrics for a more reliable assessment, some of which maintain the IRR notion as a building block while some others dispense of it. We show that the problem of fictitious short positions can be solved by resting on the IRR notion. Specifically, we bring together the notion of average internal rate of return (AIRR) developed by Magni (2010, 2013a,b) with Cuthbert’s (2017) minimal decomposition of a transaction into pure investments – this enables us to construct a measure that we call the pure-investment average internal rate of return (PIAIRR), and which can be used by analysts to assess the economic profitability of real estate investments while getting rid of some of the IRR’s drawbacks.
Keywords: Performance measurement, private equity, pure investment, rate of return, minimal decomposition, weighted average, IRR, real estate
JEL Classification: G00, G10, G11, G12, G22 , R30
Suggested Citation: Suggested Citation