ROC, ROE, IRR…WTF?!

ROC, ROE, IRR…WTF?!

Where would we be without acronyms? There’s probably even an acronym for acronyms.

The first three (definitely not the last one), came from a question Hilary fielded on her popular podcast series. Basically, the toss-up was – what is more relevant to doing a project – Return On Cost or Internal Rate Of Return? I threw in an extra one to add to the ‘confusion’ – Return On Equity. Bearing in mind the wide range of experience our readers possess, I’ll start with what they are in layman’s terms.

ROC – return on costs – is obtained when you express your profit as a percentage of total development costs. So, making $200,000 profit from a total development cost of $1,000,000 would produce a 20% ROC. ROC is sometimes referred to as MOC (margin on cost) or developer’s margin. On a small townhouse project, a commercial financier might be looking for 18% – 20%.

ROE – return on equity – is your profit expressed as a percentage of the equity you put into the project. So, if you put in $400,000 equity and you made $300,000 profit your ROE is 75%. It has no relationship to time ie. how long the project took to make the $300,000 profit. Depending on the lending ratio of the financier, the range would typically be 60% – 80%.

IRR – internal rate of return – measures the return on equity, expressed as a percentage, taking into account the time value of money (TVM) – no, not another acronym. It makes sense that if you were looking at two projects with similar ROC’s and one took one year and another two years, you would go for the quicker one. On a small townhouse project, a commercial financier might be looking for 20% – 30%.

Some feasibility programs calculate these performance indicators for you, so it is easy to compare. Commercial financiers look at ROC as a standard measure of the performance of a project, but they also have a peek at the IRR.

I just had a look at a 6-townhouse feasibility I did this week. The ROC was 19.9%, the ROE was 67% and the IRR was 31%. It’s a deal. Of course,  to get that far I had to know the GRV and calculate the TDC taking into account the financier’s LVR and not forgetting the GST. I’m off to have two Panadol.

Regards,

Bob Andersen

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