Beware of AAR
When IRR is looking worn and tired, there's always AAR
You’re reviewing two offering decks side by side. Deal A advertises a 22% annual return. Deal B shows 15%. Same hold period, same investment amount, same asset class.
Deal A looks like the obvious winner, until you realize Deal A is quoting AAR and Deal B is quoting IRR.
If you’ve been reading this newsletter for a while, you already know IRR can be easily manipulated by timing cash flows. Today is Part 2 of that discussion: how ARR might look much better than IRR.
At the end, I’ll show you a better way to evaluate a deal (and a simple prompt that lets you calculate IRR yourself from any offering deck in about 30 seconds). Spoiler alert: there is no single perfect metric (but I’ll show you how they interact and what they mean).
👉 Read this first (on how to make IRR look pretty):
Invest in real estate deals? You’ll like our case studies:
What is AAR?
Average Annual Return is the simplest return calculation in real estate. You take your total profit (all distributions plus your proceeds at sale, minus your original investment), divide by the number of years, then divide by your initial investment.
Example:
You invest $100,000 in a 5-year syndication.
You receive $38,000 in cumulative cash flow over those five years and
$173,000 back at sale (including return of capital).
Your total profit is $111,174 (cumulative cash received less $100K investment).
AAR says: $111,174 ÷ 5 years ÷ $100,000 = 22.2% per year.
Amazing, no? The trouble is, that number treats every dollar equally regardless of when you received it. The $5,000 you got in Year 1 counts the same as the $173,000 lump sum you didn’t see until Year 5.
“Leyla, just look at DPI, it’s airtight.” Oh, do I have news for you:
