Cash-on-cash return tells you this year's yield. Cap rate tells you the property's yield. But neither captures the full picture over a multi-year hold.

IRR (Internal Rate of Return) is the gold standard for evaluating real estate investments because it accounts for all cash flows over time—including appreciation at sale.

What is IRR?

IRR is the annualized rate of return that makes the net present value of all cash flows equal to zero. In plain English: it's the annual return your investment actually earned, accounting for when you got your money back.

Think of it as the interest rate your investment effectively "paid" you.

Why IRR Matters in Real Estate

Real estate returns come from multiple sources at different times:

• Year 1-5: Annual cash flow
• Year 5: Large gain when you sell

IRR combines these into a single, comparable return figure.

Example:

• You invest $100,000
• You receive $8,000/year cash flow for 5 years
• You sell and get $150,000 back

Simple math might say: ($40,000 cash flow + $50,000 gain) ÷ $100,000 = 90% total return over 5 years = 18% annually.

But IRR is actually 14.9%, because it accounts for the timing—you didn't get that $50,000 gain until year 5.

Why Timing Matters

Two investments with identical total returns can have very different IRRs:

Investment A:

• Year 0: -$100,000
• Year 1: $50,000
• Year 2: $50,000
• Year 3: $50,000
• Total return: $50,000 (50%)
• IRR: 23.4%

Investment B:

• Year 0: -$100,000
• Year 1: $0
• Year 2: $0
• Year 3: $150,000
• Total return: $50,000 (50%)
• IRR: 14.5%

Same total profit, but Investment A has higher IRR because you got money back sooner.

This is the "time value of money"—a dollar today is worth more than a dollar tomorrow.

Typical IRR Targets in Real Estate

Higher target IRR = higher risk profile.

Factors That Influence IRR

1. Hold Period

Shorter holds often produce higher IRRs (same profit over less time).

2. Leverage

Leverage amplifies returns (and risk).

Same property, different leverage:

• All cash: 10% IRR
• 50% LTV: 14% IRR
• 75% LTV: 18% IRR

3. Appreciation

Appreciation at sale often drives the majority of IRR in real estate.

Key Takeaways

• IRR = annualized return accounting for all cash flows and timing
• It's the "true" return that makes NPV of all cash flows equal zero
• Timing matters: sooner cash flows = higher IRR
• Typical real estate IRR targets: 12-20% depending on strategy
• Leverage, hold period, and appreciation significantly impact IRR
• Use IRR alongside equity multiple for complete picture
• Be skeptical of projected IRRs—verify assumptions

IRR is the most comprehensive single metric for evaluating real estate investments. But it's not perfect—understand its limitations and always verify the assumptions behind any projected IRR before investing.