What Is Internal Rate of Return?
IRR is the annualized rate of return an investment is expected to generate over its full holding period, accounting for the timing and size of all cash flows — including the eventual sale.
Internal Rate of Return in plain English
IRR turns a whole investment - the money you put in, every year of cash flow and the sale at the end - into one annual rate. It is the compound yearly return that makes everything you receive worth exactly what you put in.
Because it counts when money arrives, IRR rewards getting cash back sooner. Two deals that return the same total can have very different IRRs.
Advanced explanation
IRR is the discount rate at which the net present value of all cash flows - the initial investment, periodic cash flows and sale proceeds - equals zero. Unlike cash-on-cash return, it reflects the timing of every cash flow. It implicitly assumes interim cash flows are reinvested at the IRR, and can be ambiguous when cash flows change sign more than once.
Formula
Σ Cash Flowₜ ÷ (1 + IRR)ᵗ = 0- Cash Flow
- Net cash in each period t: negative for the investment, positive for income and sale proceeds.
- IRR
- The rate that makes the present value of all cash flows sum to zero.
There is no closed formula; IRR is solved by iteration.
It implicitly assumes interim cash is reinvested at the IRR, and can have more than one answer when cash flows change sign more than once.
Worked example
IRR on a five-year rental hold
Illustrative example - round numbers, not current market data. Calculated with Reaixo's calculator engines.
Assumptions
- Equity invested at purchase
- $100,000
- Cash flow to the investor
- $6,000 a year for 5 years
- Net sale proceeds at the end of year 5
- $140,000
| Step | Calculation | Result |
|---|---|---|
| 1. Cash flows by year | Y0: −$100,000, Y1: $6,000, Y2: $6,000, Y3: $6,000, Y4: $6,000, Y5: $146,000 | $170,000 back in total |
| 2. Solve for the rate where NPV = 0 | Σ cash flowₜ ÷ (1 + IRR)ᵗ = 0 | 12.26% |
Internal rate of return: 12.26%. Every dollar invested earned the equivalent of 12.26% a year, compounded, once the timing of each payment is counted. A savings account paying less than that would have been the weaker choice; one paying more, the stronger.
What this calculation leaves out
- IRR is solved by iteration, not a closed formula; the figure comes from the same solver as Reaixo's investment projections.
- It assumes interim cash could be reinvested at the IRR and can be misleading when cash flows change sign more than once.
Why it matters
Unlike cap rate or cash-on-cash return, IRR captures the full multi-year picture, including appreciation and the timing of cash flows.
A sale price assumption a few percent too high can add several points of IRR, so check the exit assumptions before trusting a projected IRR.
When Internal Rate of Return is used
- Comparing investments with different holding periods and cash-flow timing.
- Setting hurdles in a syndication waterfall (for example, a higher sponsor share above a 12% IRR).
- Testing how sensitive a deal is to the sale price or holding period.
Common mistakes
- Comparing IRRs without checking the equity multiple and holding period.
- Trusting a projected IRR driven mostly by an optimistic sale price.
- Comparing levered and unlevered IRRs.
Compare and common questions
Internal Rate of Return: frequently asked questions
What is a good IRR for real estate?
There is no single number. It depends on risk, leverage and the alternatives; compare IRRs only for deals with similar risk and calculated the same way.
How is IRR different from ROI?
ROI compares total gain with cost and ignores timing. IRR is an annual rate that accounts for when each dollar arrives.
Why can a high IRR be misleading?
Because a quick return of a small profit can produce a high IRR. The equity multiple shows how much money was actually made.
Related Terms
Where it fits
- Investing, Exit: before this, Depreciation Recapture; next, Equity Multiple.
More Investing Terms
Recommended next step
Project cash flow, appreciation and sale proceeds and see the IRR they produce.
Investment ROI calculator →Apply it to a specific property: Five-Year Investment Projection.
Sources and review
No regulator defines this term; the page follows common industry practice.
Where this applies: Not regulated. Investment and valuation ratios are industry and appraisal conventions; lenders, appraisers and analysts may define inputs differently, so check how a figure was calculated.
Last reviewed: · Updated:
Examples use illustrative figures; rules of thumb are labelled as such. Rates, limits and program rules change - confirm current figures with your lender or a qualified professional.
This definition is provided for general educational purposes and is not financial, legal, tax, or real estate advice. Verify important decisions with appropriately qualified professionals.
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