Internal rate of return (IRR) is the annualized discount rate that makes the net present value of all of a deal's cash flows equal to zero. It expresses a real estate investment's time-weighted return as a single percentage, accounting for the exact timing of every dollar invested and every dollar received across the hold.
How Is Internal Rate of Return Calculated?
Internal rate of return is calculated by solving for the discount rate that sets net present value to zero across the full cash flow stream. The formula is 0 = the sum of each period's cash flow divided by (1 + IRR) raised to that period, including the initial equity outflow. IRR has no closed-form solution.
Because the equation cannot be rearranged to isolate IRR, analysts use Excel's IRR function for annual periods or XIRR for cash flows on irregular dates. XIRR is the more accurate choice in real estate, where distributions and capital calls rarely land on clean annual boundaries. According to J.P. Morgan and LoopNet, IRR is valued precisely because it factors in when each cash flow occurs, not just how much.
Input | Definition |
Initial investment | Equity contributed at closing, entered as a negative cash flow at time zero |
Interim cash flows | Annual or periodic distributions from operations across the hold |
Reversion cash flow | Net sale proceeds received when the property is sold |
IRR | The single discount rate that makes the net present value of all the above equal zero |
One structural warning: if the cash flow stream changes sign more than once, for example a large capital call midway through the hold, the equation can produce multiple IRRs or none. When that happens, analysts use modified internal rate of return (MIRR), which assumes a stated reinvestment rate rather than the IRR itself.
What Is a Good IRR in Commercial Real Estate?
A good IRR depends on the risk profile of the strategy, not a single universal number. Stabilized core deals typically target an 8% to 12% IRR, value-add deals aim for roughly 13% to 17%, and opportunistic or ground-up development often requires 18% or more, per LoopNet. A higher target IRR is the market's price for taking on more risk.
The reason the target rises with risk is that IRR is a projection, and projections carry error. A development pro forma leans heavily on assumptions about lease-up pace, construction cost, and exit cap rate, any of which can move the realized IRR far from the underwritten figure. A stabilized asset with in-place leases has fewer moving parts, so a lower IRR is acceptable because the number is more likely to hold.
Strategy | Typical target IRR |
Core (stabilized) | 8% to 12% |
Value-add | 13% to 17% |
Opportunistic / development | 18% or higher |
The operator-side point is that IRR is only as honest as the exit assumption behind it. A large share of a five-year deal's IRR usually comes from the reversion, so a compressed exit cap rate can flatter the return without a single operational improvement. Ranges here are representative industry targets, not guarantees, and should be stress-tested against a conservative exit.
Example
An investor contributes $1,000,000 in equity at closing. The property distributes $60,000 per year for four years, then in year five distributes a final $60,000 plus $1,300,000 in net sale proceeds, for a year-five cash flow of $1,360,000. Solving for the rate that sets net present value to zero gives an IRR of about 10.83%.
Year | Cash flow |
0 | ($1,000,000) |
1 | $60,000 |
2 | $60,000 |
3 | $60,000 |
4 | $60,000 |
5 | $1,360,000 |
Total distributions are $1,600,000 on $1,000,000 invested. That produces a 1.6x equity multiple, yet the IRR is only 10.83%, because the timing of the cash matters. Most of the return arrives in year five, so the annualized rate is modest even though the investor received 1.6 times the equity back. This gap between multiple and IRR is why underwriters report both.
Variations and Edge Cases
Internal rate of return is not a single stable figure: it shifts with the reinvestment assumption, the cash flow dates, and the hold period. The metric assumes interim distributions are reinvested at the IRR itself, which is often unrealistic. The table below covers the variants an underwriter should separate before quoting one number.
Variant | Treatment |
IRR vs XIRR | IRR assumes evenly spaced periods; XIRR uses actual dates and is more accurate for real distributions |
Reinvestment assumption | Standard IRR assumes cash flows are reinvested at the IRR; MIRR assumes a lower, stated reinvestment rate |
Multiple sign changes | A mid-hold capital call can produce multiple IRRs or none; MIRR resolves the ambiguity |
Levered vs unlevered IRR | Levered IRR reflects returns after debt; unlevered IRR strips out financing to isolate property performance |
Short holds | A short hold can post a high IRR on a small absolute profit; pair it with equity multiple |
The most common mistake is trusting IRR without the exit assumption and hold period that produced it. A 20% IRR on a one-year flip and a 20% IRR on a ten-year hold describe very different deals, and IRR alone will not tell them apart.
Internal Rate of Return vs Equity Multiple
Internal rate of return is often confused with equity multiple, and the two answer different questions. IRR is the annualized, time-weighted rate of return that sets net present value to zero. Equity multiple is total cash returned divided by equity invested, ignoring timing. IRR tells you how fast capital grew; equity multiple tells you how much.
The two can disagree sharply. A deal that returns capital quickly can post a high IRR but a low equity multiple, while a long hold can show a strong multiple and a modest IRR. Underwriters read them together, because neither is complete alone.
Frequently Asked Questions
What is a good IRR for a real estate investment?A good IRR depends on risk. Stabilized core deals commonly target 8% to 12%, value-add deals target roughly 13% to 17%, and opportunistic or development deals often require 18% or more. Higher risk demands a higher IRR.
What is the difference between IRR and cash-on-cash return?IRR is a time-weighted return across the entire hold, including the sale, while cash-on-cash return measures a single year's cash distribution against equity invested. IRR captures timing and the exit; cash-on-cash is a snapshot of one year's income.
Why can a deal have more than one IRR?A deal can have more than one IRR when its cash flow stream changes sign more than once, such as a large capital call mid-hold. In that case analysts use modified internal rate of return (MIRR), which relies on a stated reinvestment rate to produce a single answer.
Related Terms
Equity Multiple
Net Operating Income
Cap Rate
Underwriting
Pro Forma