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Calculating Commercial Real Estate Investment Returns [Three Methods] - YouTube
Channel: Tyler Cauble
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everyone's heard of cash on cash returns
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but there are other ways to determine
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how successful a real estate investment
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is
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today i'm going to show you how to
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calculate commercial real estate
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investment returns using my three
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go-to calculations cash on cash internal
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rate of return
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and return on equity which is where many
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investors miss out if you're investing
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in commercial real estate you're
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probably looking for a return on your
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capital and one of the most attractive
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aspects of having commercial real estate
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investments is that you can receive
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monthly dividends through cash flow
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while hopefully gaining appreciation on
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the property but you need to have a
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concrete method to be able to determine
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which investment you should take on next
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or how your current portfolio has
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performed
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after acquisition up first the return on
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investment roi
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or cash on cash return the roi or cash
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on cash return is the most
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commonly used investment measurement in
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all of real estate
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return on investment is calculated by
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taking the monthly or
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annual cash flow of an asset and
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dividing it by the total amount of money
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you have invested in the property
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for example say a property receives ten
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thousand dollars a year in cash flow and
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you invested
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a hundred thousand dollars you divide
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that ten thousand dollar cash flow
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by the one hundred thousand 000 down
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payment which gives you a
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10 cash on cash return in this scenario
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your investment is giving you 10 percent
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of the original amount of money you
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invested every year
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not a bad deal you could also consider
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cap rates as a member of the
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cash-on-cash return
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family since they're technically a
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cash-on-cash return if you were to buy a
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property with all cash
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no debt so what are the benefits of
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using roi well
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there's a reason the cash on cash return
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is the most
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commonly used measurement in all of real
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estate it's very
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simple to understand it gives you a
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quick snapshot of the profitability of a
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deal in a way that is
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easily compared to the stock market or
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other investment vehicles and the roi is
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just a great way to determine a return
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since
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it's based on the cash out of pocket you
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will be deploying but
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there are also drawbacks of using the
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roi as well
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while the simplicity of a cash on cash
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return is a benefit it is also a
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drawback
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the roi only gives you a measurement of
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return based on the
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initial investment you made into a
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property at a specific point in time
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your time value of money isn't taken
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into account which isn't
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too important for some investors and it
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also doesn't measure your return
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based on your built up equity in the
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property next up
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the internal rate of return or irr the
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internal rate of return is a more
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high level investment measurement this
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calculation takes your initial
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investment
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cash flow distributions and the length
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of the investment into account in order
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to determine your returns over time
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there's no simple way of actually
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calculating irr
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so i highly recommend using a computer
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program like excel
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so here's an example in this scenario
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you make a 100
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000 investment for a period of five
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years
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over that time period you've received 45
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000
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in cash flow which some investors would
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just equate to a 45
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cash on cash return over that five year
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period that's certainly not a bad return
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but since irr takes into account the
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amount of money you have
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invested over a time period you'll see
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that that return according to the irr
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is actually 8.83 percent so what are the
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benefits of using the irr well
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internal rates of return account for the
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amount of time that your money is
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invested
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unfortunately while a cash on cash
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return is helpful to determine the
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initial
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quality of an investment it's only a
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snapshot frozen in top
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utilizing irrs gives you the opportunity
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to compare
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different lengths of investments as well
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as their prospective returns
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to help you determine which direction is
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best for you to take
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but there are also some drawbacks of the
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irr too calculating your internal rate
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of return can be
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very complicated it's not a measurement
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you can simply perform in your head
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while
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looking at a potential investment
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opportunity you will have to add it to
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your underwriting spreadsheets
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your irr calculation will also take into
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account future cash flows and estimated
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sales costs which
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just aren't concrete numbers finally the
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return on equity
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or roe the return on equity is arguably
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the most forgotten or neglected
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measurement of investment returns but it
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should be
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at the top of every sophisticated
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investor's list
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roe takes into account your total equity
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including equity that has built
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up over time and measures your cash on
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cash returns against that
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instead of your initial investment so
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for example you buy a property and have
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a hundred thousand dollars in equity to
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start
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as your property appreciates by three
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percent each year your cash flow remains
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the same at ten thousand dollars per
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year but your return on equity
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decreases this scenario is very common
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among triple net properties where the
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rent remains flat for extended periods
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of time you're building up equity in the
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property while your cash flow remains
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the same so
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while you may have had a strong initial
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return on investment
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each year that number will decrease you
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now have what i call
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captive equity that you've created in
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this project but
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isn't returning anything on your
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investment so you can choose to either
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refinance
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take out a line of credit or sell that
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asset in order to put that capital into
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play
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so what are the benefits of the roe
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calculation well
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your return on equity will show you if
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you have capital in play
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that just isn't giving you a strong
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enough return at some point in your
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investment you will cross a threshold
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where the returns on the built up equity
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are
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lower than other opportunities you may
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have return on equity can tell you when
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it's time to pull that capital out or
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divest of that project
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now are we also has its drawbacks while
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the return on equity is an
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excellent measurement and it's one of my
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favorites it tells you returns based off
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of essentially
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phantom equity sure the equity is there
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in the property but you either have to
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sell the property to realize the gain
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from that equity
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refinance or take out a line of credit
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it's nice to know that you have more
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capital created in a project but
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it can also be frustrating for investors
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if you don't have any opportunities out
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there to move that capital into
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so which is best roi irr
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or return on investment well that's an
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excellent question sophisticated
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investors will be utilizing
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all three of these consistently
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throughout each project
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in order to better monitor their money
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as it works for them
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every investor will have their favorite
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real estate calculation though and that
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will depend on the type of investments
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they're making
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one nice aspect of these measurements is
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that they give you a different view of
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your returns
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at each stage of your investment before
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during and after i recommend using all
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three throughout the life of your
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project
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so that you can maximize your potential
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investment returns so there's your
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rundown on calculating commercial real
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estate investment returns
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if you found value in this video please
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be sure to like it and subscribe to the
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channel for more commercial real estate
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investing strategies
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updates and more
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