Note that "realized" means money that you've received. A dividend or distribution is a form of realized investment proceeds. When you sell an investment entirely, it also becomes realized. On the other hand, an "unrealized" investment is one you still own. For example, if you own shares of a REIT and they've doubled, the gain is known as an unrealized gain until you sell your shares.
So, let's say you invested $100,000 in a private-equity real estate deal. After a few years, you've received $20,000 in cumulative distributions. And based on a recent appraisal of the property, your share's valuation has increased to $150,000. You would add the unrealized value to your distributions, which would be a total of $170,000 in value you've received from your initial $100,000 investment. Dividing these numbers would produce a MOIC of 1.7, meaning your investment has increased by a total of 70%.
Advantages and shortcomings of MOIC
The main advantage of using multiple on invested capital to express your investment performance is that it breaks your return down into one easy-to-understand number. Metrics like annualized returns and internal rate of return (IRR) can be confusing to understand, especially if you're interested in the total performance of your investment. MOIC tells you how much your investment has returned from start to finish.
However, the all-in-one nature is also the biggest shortcoming of using multiple on invested capital to calculate investment returns. Specifically, it doesn't account for the amount of time you've held the investment. For example, if you have the choice between a MOIC of 2.0 times after four years or 2.3 times after five years, which is the better investment return? You can certainly figure it out, but with extra steps. The MOIC alone doesn't tell the whole story.
Other ways to measure real estate investment returns
Because it doesn't take time into account, it can be useful to incorporate other investment return metrics into your analysis in addition to MOIC. Just to name a few:
Internal rate of return (IRR)
Internal rate of return, or IRR, is an annualized investment return metric commonly used to express the performance of real estate investments. The formula for calculating IRR can be a little complicated, and there are some excellent IRR calculators available online you can use, but the point is that this levels the playing field between investments you've owned, or plan to own, for different lengths of time.
Cash-on-cash return is a return metric that's most useful when you use leverage (borrowed money) to invest, as it measures the amount of money you make on an investment as a percentage of the actual cash you invest. For example, if you buy a property to fix and flip for $125,000 with $50,000 down and you sell it for net proceeds of $200,000, your cash-on-cash return would be calculated as the $75,000 profit divided by the $50,000 you invested, or 150%.
Capitalization rate (cap rate)
This is an income-based metric, meaning that it evaluates your income from a real estate investment, not gains in market value. Cap rate is calculated as a property's net operating income as a percentage of its purchase price or market value. For example, a property that costs $1 million and generates $80,000 in annual operating income has a cap rate of 8%.
One of the biggest shortcomings of cap rate analysis is that it doesn't consider debt. For example, if you have a rental property with a mortgage, the property's cap rate doesn't tell you the actual amount of money that will show up in your bank account each month. That's where cash flow comes in -- it's the difference between all of your expenses (including debt service) and the rental income the property produces.
The Millionacres bottom line
Multiple on invested capital can be helpful to express the actual or expected returns of a commercial real estate investment from start to finish and can be particularly useful if you're a private-equity investor. However, like all investment metrics, it doesn't provide a clear picture of an investment's performance all by itself and is best used in combination with some of the other metrics discussed here.