What Is IRR (Internal Rate of Return) in Real Estate?

IRR (Internal Rate of Return) is a real estate investment metric that estimates a property’s long-term return by calculating the discount rate at which the present value of future cash flows equals the initial investment. Investors use IRR to compare deals and forecast profitability over time.

How IRR Works in Real Estate

IRR looks beyond simple income and expenses. It includes cash flow over multiple years, potential rent increases, operating costs, and the estimated profit when the property is sold.

IRR is the discount rate that makes:

Total Present Value of Cash Flows = Initial Investment

  • Accounts for changing income over time
  • Includes your expected sale price at the end of the investment
  • Helps compare deals with different timelines
  • Higher IRR generally indicates a stronger investment

Example of IRR in Real Estate

An investor buys a rental property for $300,000. Over 5 years, the property generates increasing net cash flow. In year 5, the investor sells the property.

Using all projected cash flows plus the sale proceeds, the IRR calculation determines the annualized return — for example, an IRR of 12%. This means the investment is equivalent to earning 12% per year over the entire holding period.

IRR vs. Cap Rate vs. GRM

  • IRR – Considers multi-year cash flow + sale price; best for long-term forecasting
  • Cap Rate – Measures current return based on NOI and price
  • GRM – Simple ratio comparing property price to gross rent

IRR is the most comprehensive metric but also the most complex. Cap rate and GRM help with quick comparisons, while IRR helps with full investment modeling.

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