An investor models all the cash going into a property and all the cash coming out over several years, then solves for the discount rate that makes the net present value zero. That rate is the internal rate of return, or IRR. It expresses the annualized yield of the investment.

IRR accounts for the timing of cash flows, making it more comprehensive than simple cash-on-cash return. It is sensitive to the accuracy of projections for rents, expenses, financing, and sale price. Small changes in exit assumptions can swing the IRR significantly.

Investors use IRR to rank deals and to compare real estate against other asset classes. Because it is an estimate based on future assumptions, it should be stress-tested under different scenarios. A high projected IRR is attractive only if the assumptions behind it are realistic.

• Annualized yield considering timing of cash flows
• Solves for the rate that sets NPV to zero
• Sensitive to exit and operating assumptions
• Used to compare investment opportunities