How Financial Management Rate of Return (FMRR) Influences Real Estate Investing Decisions

Published: 23rd June 2011
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Amongst the many real estate investing returns used by investors to measure profitability of investment property, the financial management rate of return (or FMMR) undoubtedly is one of the most unique yet lesser known returns. Financial management rate of return was conceived by the Commercial Investment Real Estate Institute (at least I think it was) because it is presented on a regular basis by CIREA to those who are seeking the Certified Commercial Investment Member (or CCIM) designation and I have never come across the concept employed anywhere else.



Alright, so what exactly is the financial management rate of return, what makes it unique, and how do you calculate it?



Let's start with the concept behind the return. That real estate investors are commonly confronted with having to pick amongst alternate investment opportunities that Internal Rate of Return (IRR) isn't going to adequately offer. As a consequence then it seemed unavoidable to introduce FMRR for investors who want to make comparisons between those investments on an "apples-to-apples" basis.



In order to do this, two components known as the "safe rate" and the "reinvestment rate" have been integrated into the FMMR model by the CIREI.



1) Safe Rate In view here is the rate an investor would "safely" collect on money put into an account where it should be understood to be highly liquid and can be removed on a day-to-day basis without loss of either principal or interest.



The concept is a reasonable one. If an investor is collecting a positive sum of dollars per month from a certain rental property after loans and income taxes are assessed then it can be assumed that those monies would not be tucked under a mattress. Rather that the investor would instead deposit those funds in the bank and collect what the institute refers to as this "safe rate".



2) Reinvestment Rate This is concerned with monies that would not be necessary to meet other money needs of the real estate asset and could be "reinvested" in some other sorts of "run of the mill" financial investments therein earning the investor additional after-tax yields known as the "reinvestment rate".



The computation to get FMMR is particularly complex. So you will need a real estate calculator or quality real estate investing software solution to undertake it.



So let me just explain what it does in practice with projected annual revenues.



First, all the negative cash flows that exist are discounted back year-by-year to the investment year (i.e., year zero) at the safe rate unless they are confronted with a positive cash flow and are removed. Then the positive cash flows (if any are present and still exist) are compounded forward at the reinvestment rate to the year of sale (when you expect to sell the property). Negative cash flows that do in fact survive the trip are included with the initial investment in year zero, similarly the positive cash flows are included with the cash proceeds in the year of sale, and each and every year in between become zeros.



In other words, despite the number of annual revenue projections you are making, the schema will always wind up with a sum total of negative dollars in year zero, a sum total of positive dollars in the final year, and zero amounts for the years in between.



Okay, now the schema is amply constructed we solve for the financial management rate of return (FMRR) merely by using that schema and computing the internal rate of return (IRR).





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James Kobzeff is the developer of ProAPOD - leading real estate investment analysis software solutions since 2000. Create rental property cash flow and rates of return analysis and marketing presentations in minutes! Includes Financial Management Rate of Return. Learn more => http://www.proapod.com

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