Definition
Unlevered return is the return a real estate investment generates assuming the property is purchased with no debt (all-equity). It measures the performance of the asset itself, independent of financing decisions.
Unlevered return is commonly reported as unlevered IRR (internal rate of return) and/or an unlevered equity multiple based on property-level cash flows before financing.
Unlevered vs. Levered Return
- Unlevered return: based on NOI (and other property cash flows) after operating expenses and reserves, but before debt service.
- Levered return: the return to equity after the effects of debt (interest, principal, fees, refinance proceeds).
Debt can increase returns when the property yield exceeds the cost of debt, but it can also amplify downside risk. Unlevered return is a cleaner way to compare deals “apples-to-apples.â€
What Cash Flows Are Used
Unlevered cash flows typically include:
- Net operating cash flow: NOI minus recurring reserves/CapEx (depending on the model’s definition).
- Capital events: renovation costs, leasing costs, and other capital expenditures.
- Sale proceeds: sale price minus selling costs (brokerage, transfer taxes, closing costs).
They typically exclude loan proceeds, interest, principal payments, and lender fees.
Common Metrics
- Unlevered IRR: the discount rate that sets the present value of unlevered cash flows to zero.
- Unlevered equity multiple: total unlevered cash returned ÷ total unlevered cash invested.
- Unlevered yield: a period-by-period cash flow yield (varies by definition).
Why It Matters
- Comparability: compare different deals without getting distracted by financing structures.
- Asset quality: reveals whether returns come from operations/value creation or from leverage.
- Capital allocation: helps decide where equity is best deployed when debt availability changes.
- Risk clarity: separates property risk from financing risk (rate volatility, refinance risk, covenants).
Example
An investor buys a property for $10,000,000 (all-cash). The property produces $650,000 of net operating cash flow per year (after operating expenses and reserves). After 5 years, the property sells for $11,500,000 net of sales costs.
The unlevered cash flows are the annual operating cash flows plus the net sale proceeds. An unlevered IRR is calculated from those cash flows and reflects the asset’s performance without debt magnification.
Common Pitfalls
- Inconsistent definitions: some models use NOI, others use NOI minus reserves/CapEx—know what’s included.
- Ignoring CapEx: using NOI alone can overstate unlevered performance in capital-intensive assets.
- Overweighting sale price assumptions: unlevered returns can still be highly sensitive to terminal cap rate.
- Comparing different risk profiles: a higher unlevered return may reflect higher operational or market risk.