What is Internal Rate of Return (IRR)?
Internal rate of return (IRR) is a financial metric that measures the annualized rate of return at which the net present value of all cash flows from an investment equals zero. In simpler terms, IRR accounts for both the timing and magnitude of every cash flow, making it one of the most comprehensive return metrics for real estate.
How IRR differs from ROI
Basic ROI divides total profit by total investment and ignores when cash flows occur. IRR gives more weight to money received sooner. Two investments might have the same ROI, but the one that returns money faster has a higher IRR because that money can be reinvested sooner.
When to use IRR
IRR is most useful for investments with multiple cash flows over time, like rental properties or BRRRR deals. A rental generates monthly income, may require capital expenditures, and eventually produces a sale. IRR captures all these flows and their timing in a single number. For simple flips with one inflow and one outflow, annualized ROI is sufficient.
IRR benchmarks
Institutional investors target 15-20% IRR for value-add multifamily, 20-25%+ for opportunistic investments, and 8-12% for stabilized core assets. Individual investors doing BRRRR or small multifamily typically target 15%+. Anything above 20% IRR is considered excellent.
Limitations
IRR assumes cash flows can be reinvested at the IRR rate, which may not be realistic. It can produce misleading results when cash flows change direction multiple times. And IRR does not tell you absolute profit: a 50% IRR on $10,000 is less valuable than 20% IRR on $500,000. Always consider IRR alongside total profit and equity multiple.