Key Takeaways:

IRR measures the annualized return of an investment accounting for the time value of money
Unlike Cash-on-Cash return, IRR considers when cash flows occur and your eventual exit
A "good" IRR for rental properties is typically 12-20%+ depending on risk level
IRR is most useful when comparing investments with different holding periods

Internal Rate of Return (IRR) is considered the gold standard for measuring real estate investment performance. While metrics like Cash-on-Cash return show you what you're earning right now, IRR tells you the complete story - including appreciation, loan paydown, and your eventual sale. Here's everything you need to know to calculate and use IRR effectively.

What is IRR (Internal Rate of Return)?

IRR is the annualized rate of return that makes the Net Present Value (NPV) of all cash flows equal to zero. In simpler terms: it's the effective annual interest rate your investment earns over its entire life.

The Concept:

If you invest $50,000 today and receive various cash flows over 5 years, then sell for a profit, IRR tells you what equivalent annual interest rate you earned on that $50,000.

IRR = The discount rate where:
Present Value of Inflows = Present Value of Outflows

Why IRR Matters

• Accounts for the time value of money
• Includes appreciation and sale proceeds
• Captures loan paydown benefits
• Allows apples-to-apples comparison across investments
• Standard metric used by institutional investors

IRR Limitations

• Requires assumptions about future sale
• More complex to calculate than CoC
• Sensitive to timing of cash flows
• Assumes reinvestment at same rate
• Garbage in, garbage out - depends on projections

IRR vs Other Return Metrics

Metric	What It Measures	Time Horizon	Best For
IRR	Annualized total return	Full hold period + exit	Complete investment analysis
Cash-on-Cash	Annual cash return on cash invested	Single year	Current cash flow assessment
Cap Rate	NOI as % of purchase price	Single year (no financing)	Comparing properties
Total ROI	Total profit / Initial investment	Full hold period	Overall profit assessment

Example: Why IRR Matters

Two properties both have 10% Cash-on-Cash return. But:

• Property A: In appreciating market, sells for 30% profit after 5 years → IRR: 18%
• Property B: In flat market, sells for same price after 5 years → IRR: 11%

The CoC return looked the same, but IRR reveals Property A is significantly better.

Step-by-Step IRR Calculation

Let's walk through a complete IRR calculation with a realistic example:

Example Property:

Purchase Price: $300,000

Down Payment (25%): $75,000

Closing Costs: $8,000

Initial Investment: $83,000

Annual Cash Flow: $6,000 (Year 1)

Cash Flow Growth: 3% per year

Hold Period: 5 years

Sale Price: $360,000 (20% appreciation)

List All Cash Flows

Year	Cash Flow
Year 0	-$83,000
Year 1	+$6,000
Year 2	+$6,180
Year 3	+$6,365
Year 4	+$6,556
Year 5	+$6,753 + $138,000 (sale proceeds) = +$144,753

*Sale proceeds = Sale price - Remaining loan balance - Selling costs

Use Excel or Google Sheets IRR Function

=IRR(A1:A6)

# Where A1:A6 contains: -83000, 6000, 6180, 6365, 6556, 144753

Result

IRR = 16.8%

This means your $83,000 investment effectively earned 16.8% per year when accounting for all cash flows and the final sale.

What's a Good IRR for Rental Properties?

IRR Range	Assessment	Typical Scenario
< 8%	Below average	May underperform stock market
8-12%	Acceptable	Stable market, lower risk property
12-18%	Good	Strong cash flow + moderate appreciation
18-25%	Excellent	Value-add, good market timing
> 25%	Exceptional (verify assumptions)	BRRRR, fix-and-flip, rapid appreciation

Important Note:

IRR is only as good as your assumptions. If you assume 5% annual appreciation but the market only grows 2%, your actual IRR will be much lower. Be conservative with appreciation estimates - it's better to be pleasantly surprised than disappointed.

Factors That Impact IRR

Increases IRR

• Higher property appreciation
• Stronger annual cash flow
• Lower initial investment (higher leverage)
• Rent growth over time
• Shorter hold period (with same appreciation)
• Lower vacancy rates
• Lower maintenance costs

Decreases IRR

• Flat or declining property values
• Negative cash flow years
• High capital expenditures
• Higher selling costs
• Higher interest rates
• Longer vacancy periods
• Unexpected repairs

The Power of Leverage

Using a mortgage (leverage) typically increases IRR because you're earning returns on property appreciation with less of your own cash invested. However, leverage also increases risk - if property values decline, your IRR can turn negative quickly.

Quick IRR Calculation Methods

Method 1: Excel/Google Sheets IRR Function

=IRR(cash_flow_range, [guess])

Enter your cash flows in a column (negative for outflows, positive for inflows), then use the IRR function. The optional [guess] parameter can help if the function doesn't converge.

Method 2: XIRR for Irregular Cash Flows

=XIRR(cash_flow_range, date_range)

If your cash flows don't occur exactly annually (e.g., mid-year sale), use XIRR which accounts for exact dates.

Method 3: Financial Calculator

On a financial calculator (HP 12C, TI BA II Plus):

Enter initial investment as CF0 (negative)
Enter each year's cash flow as CF1, CF2, etc.
Press IRR/YR or IRR CPT

Skip the Spreadsheets

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Summary

IRR measures your complete investment return - including cash flow, appreciation, loan paydown, and sale proceeds.
Target 12-18% IRR for buy-and-hold rental properties in stable markets.
Use conservative appreciation estimates - 2-3% annually is realistic for most markets.
IRR is most useful for comparing investments with different holding periods or exit strategies.
Don't rely on IRR alone - also check Cash-on-Cash return to ensure positive monthly cash flow.

How to Calculate IRR for Rental Properties: Complete Guide