IRR

IRR stands for Internal Rate of Return. It's the annualized rate of return on an investment, factoring in the timing and amount of all cash flows in and out — including the eventual sale.

For real estate investors, IRR is the most complete measure of investment performance because it captures everything: down payment, ongoing cash flow, mortgage paydown, eventual sale price, and the time value of money. It tells you what your investment actually returned, annualized.

How IRR is calculated

IRR is the discount rate at which the net present value (NPV) of all cash flows equals zero. In practice, it's calculated by financial software (Excel's IRR function, calculators, spreadsheet models) — not by hand.

Inputs:

• Initial investment (cash deployed at acquisition: down payment + closing + initial repairs)
• Annual cash flows (rental income minus operating expenses minus debt service, year by year)
• Sale proceeds (sale price minus selling costs minus remaining mortgage balance, in the exit year)

The output: a single annualized percentage that represents the average annual return.

IRR example

A 5-year hold on a single-family rental:

• Year 0: Cash invested = -$93,000 (down payment + closing + initial repairs)
• Year 1: Cash flow = $5,000
• Year 2: Cash flow = $5,500 (rent increase)
• Year 3: Cash flow = $6,000
• Year 4: Cash flow = $6,500
• Year 5: Cash flow = $7,000 + Sale proceeds = $145,000 (after mortgage payoff and selling costs)

IRR ≈ 14.5% (calculated via Excel)

That 14.5% captures everything — cash flow, appreciation, mortgage paydown, and the timing of when each dollar arrived.

Why IRR is the gold standard metric

IRR captures three things that simpler metrics miss:

1. Time value of money. A dollar received in Year 1 is worth more than a dollar received in Year 5. IRR accounts for this. Cash-on-cash return doesn't.

2. Sale price impact. The exit is often the largest cash event in the deal. IRR includes it. Cash-on-cash and cap rate ignore it.

3. Mortgage paydown. Every monthly payment reduces principal, building equity. IRR captures this in the exit value. Cash flow metrics don't.

IRR vs. Cash-on-Cash vs. Cap Rate

• Cap Rate: Property's unleveraged annual yield. Single-year metric.
• Cash-on-Cash: First-year leveraged return on cash invested. Single-year metric.
• IRR: Annualized total return across the entire hold including sale. Multi-year metric.

Different metrics for different decisions:

• Comparing properties in a market: cap rate
• Sizing first-year returns on a leveraged deal: cash-on-cash
• Comparing deals across different hold periods or strategies: IRR

What's a good IRR?

Real estate IRR benchmarks vary by strategy and risk:

• Below 8%: Weak. Probably better in lower-risk investments.
• 8-12%: Solid. Stable rental in healthy market.
• 12-18%: Strong. Value-add deal, BRRRR, or appreciation play executed well.
• 18-25%: Excellent. Deep value-add, fix-and-flip, or short-hold opportunistic deal.
• 25%+: Exceptional or speculative. Often involves significant leverage or operational complexity.

IRR caveats

Sensitivity to assumptions. IRR depends on assumed exit price, rent growth, and hold period. Small changes in these inputs cause large IRR swings. Always run sensitivity scenarios.

Doesn't measure scale. A 20% IRR on $50K is $10K. A 12% IRR on $500K is $60K. IRR alone doesn't say which is the better investment — depends on what you're optimizing for.

Reinvestment assumption. IRR mathematically assumes intermediate cash flows are reinvested at the same IRR rate, which is often unrealistic. For very high IRR projects, the reported number may overstate actual return.

Rate Hero's take

For investors comparing deals or building underwriting models, IRR is the most useful single metric — but only when paired with realistic assumptions. We help investors model deals end-to-end (acquisition financing, hold-period cash flow, refinance options, exit assumptions) so the IRR calculation reflects what could actually happen, not just optimistic projections.