Internal Rate of Return (IRR) is a valuable metric commonly used to analyze real estate investments that represents the return each dollar earns while invested. IRR is the required rate to convert future cash flow to equal the equity investment. Unlike Cash-On-Cash Return, the time value of money is accounted for in the IRR. For example, the earlier cash is received, the higher the IRR will be since a dollar today is worth more than a dollar in the future.
IRR is most easily calculated by using a financial calculator or Microsoft Excel. A table below shows the annual cash flows used to arrive at a 9% IRR.
Some limitations to Internal Rate of Return (IRR) for investment analysis include discounting negative cash flows, reinvesting periodic cash flows, differences in initial investment amounts, and differences in projected holding periods.
Despite these limitations, IRR is a widely used real estate investment measurement of annualized yield on each dollar invested and is a fundamental method for investment selection and performance measurement. It is often used in conjunction with Cash-On-Cash Return in real estate investment analysis.