What it means
Formally, IRR is the discount rate at which the present value of all cash flows equals zero, which in plain terms is the yearly compound return the equity actually earns. In a property deal, the cash flows are the equity invested at the start, the distributions made during the hold, and the net proceeds after the loan is repaid on sale.
It is the standard measure across the industry precisely because it makes deals of different sizes and lengths comparable. Timing is what separates IRR from simpler measures.
A deal returning $1,000,000 of profit over three years produces a much higher IRR than the same profit over seven, and money received early can be reinvested, which the calculation reflects. That is why refinancing to return capital early can lift IRR sharply even when total profit is unchanged.
For that reason IRR is almost always quoted alongside the equity multiple, which is simply total cash returned divided by cash invested. The multiple ignores timing entirely, so the two together tell you both how fast and how much.
A deal with a strong IRR but a multiple close to 1.2x may be returning capital quickly without generating much absolute profit. Property IRRs are also quoted on different bases, and the difference is easy to miss.
Levered IRR includes the effect of mortgage debt and is what an equity investor actually receives, while unlevered IRR ignores financing and measures the property's own performance. Investors should also distinguish gross IRR from net IRR, which is after fund management fees and carried interest.
The weakness of IRR is that it is only as honest as its assumptions, and the exit assumption dominates. Most of the return in a typical five year hold comes from the sale, so the exit yield assumed at the end drives the headline number more than anything that happens in between.
Sensible appraisals test the IRR against a higher exit yield rather than presenting a single confident figure.
In practice
Real-world examples.
Example
A private investor comparing two apartment deals sees identical 1.9x equity multiples but IRRs of 14.9% and 11.2%, because the second holds for seven years rather than five. She chooses the shorter hold and redeploys the capital sooner.
Example
A development partnership refinances a completed office scheme in year two, returning 60% of the original equity to investors while retaining the asset. The early capital return lifts the projected IRR by several percentage points without changing total profit.
Example
An investment committee rejects a retail park appraisal showing a 19% IRR after testing the exit assumption. When the exit yield is widened by half a percentage point, the IRR falls below the fund's 12% hurdle and the deal no longer clears.
Think of it
“Real estate IRR is the return rate considering all cash flows and their timing.
Formula
Calculation
IRR is the rate at which the sum of all cash flows, each discounted back to today, equals zero. It is solved iteratively rather than in one line, which is why spreadsheets are used.
Consider an investor putting $2,000,000 of equity into an apartment block alongside a mortgage. The property distributes $150,000 of cash a year after debt service, which is a cash-on-cash return of $150,000 / $2,000,000 = 7.5%. At the end of year five the building is sold and, after repaying the loan and costs, the investor receives $3,000,000.
The cash flows are minus $2,000,000 at the start, $150,000 in each of years one to four, and $150,000 + $3,000,000 = $3,150,000 in year five. Solving for the rate that makes these worth zero today gives an IRR of about 14.9%. You can sanity check it: discounting at 14.9% gives roughly $130,500 + $113,600 + $98,900 + $86,100 + $1,572,900, which sums to about $2,002,000, essentially the $2,000,000 invested. Total cash returned is (5 x $150,000) + $3,000,000 = $3,750,000, so the equity multiple is $3,750,000 / $2,000,000 = 1.875x.Case study
Seen in the real world.
Kestrel Court Partners is an invented property investment firm used purely as an illustrative example. It raised $2,000,000 of equity to buy an apartment block with a mortgage, projecting annual distributions of $150,000 and a sale in year five.
The building performed as expected, distributing $150,000 a year, and sold at the end of year five for net proceeds to equity of $3,000,000. Investors received $3,750,000 in total against $2,000,000 invested, an equity multiple of 1.875x and an IRR of roughly 14.9%.
The illustrative point Kestrel made to its investors afterwards was about how close it came. The original appraisal had assumed the same exit yield at which the building was bought, and had the market shifted by half a percentage point, the sale proceeds would have been materially lower and the IRR several points weaker. From the next fund onwards, every appraisal was presented with a downside exit case alongside the base case.
Watch out
Common mistakes.
- Comparing a levered IRR from one deal with an unlevered IRR from another, which flatters the geared deal and makes the comparison meaningless.
- Quoting IRR without the equity multiple, so a fast return of capital with little absolute profit looks like a strong result.
- Accepting the appraisal's exit yield without testing it, when the sale proceeds usually drive most of the return in a five year hold.
Questions
People also ask.
What is the difference between IRR and cash-on-cash return?
Cash-on-cash measures annual distributions against equity invested in a single year, while IRR takes every cash flow across the whole hold, including the sale, into account.
Why can a project have more than one IRR?
When the cash flows change sign more than once, for example a further equity injection mid-hold, the equation can have multiple mathematical solutions and other measures should be used alongside it.
What IRR should a property investor target?
It depends entirely on risk, with stabilised income assets typically underwritten in the high single digits to low teens and development or repositioning deals expected to offer considerably more.
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