What is Financial Management Rate Of Return - FMRR
The financial management rate of return (FMRR) is a metric used to evaluate the performance of a real estate investment and pertains to a real estate investment trust (REIT). REITs are shares offered to the public by a real estate company or trust that holds a portfolio of income-producing properties and/or mortgages. The FMRR is similar to the internal rate of return and takes into account the length and risk of the investment. The FMRR specifies cash flows (inflows and outflows) at two distinct rates known as the safe rate and the reinvestment rate.
BREAKING DOWN Financial Management Rate Of Return - FMRR
Because the calculation of financial management rate of return is so complex, many real estate professionals and investors choose to use other metrics for real estate analysis. The benefit of using FMRR is that it allows investors to compare investment opportunities on par with one another.
Although the Internal Rate of Return (IRR) has long been a standard measure of return within the financial lexicon, a primary drawback is the value's inability to account for time or a holding period. As such, it's a weak indicator of liquidity, which plays a material role in determining the overall risk level of any given investment security or vehicle. For instance, when using just IRR, two funds may look alike based on their rates of return but one may take twice as long as the other to simply getting back to an original principal investment amount. Many analysts will supplement IRR or MIRR return measures with the payback period to assess the length of time required to recoup a principal investment sum.
The Modified Internal Rate of Return improves on the standard Internal Rate of Return value by adjusting for differences in the assumed reinvestment rates of initial cash outlays and subsequent cash inflows. FMRR takes things a step further by specifying cash outflows and cash inflows at two different rates known as the “safe rate” and the “reinvestment rate.”
- Safe rate assumes that funds required to cover negative cash flows are earning interest at a rate easily attainable and can be withdrawn when needed at a moment’s notice (i.e., like from a day of deposit account). In this instance, a rate is “safe” because the funds are highly liquid and safely available with minimal risk when needed.
- Reinvestment rate includes a rate to be received when positive cash flows are reinvested in a similar intermediate or long-term investment with comparable risk. The reinvestment rate is higher than safe rate because it is not liquid (i.e., it pertains to another investment) and thus requires a higher-risk discount rate.