Internal Rate of Return (IRR)

How IRR Works

IRR is a discount rate, mathematically. It is the rate at which the present value of all positive cash inflows (operating distributions + sale proceeds) equals the initial investment.

In practice IRR is calculated in Excel using the =IRR() function or in financial calculators. The formula iteratively solves for the rate that produces zero NPV.

Simple IRR Example

Investor buys a Central Florida multifamily property for $5,000,000 cash. Over a 5-year hold:

• Year 1 cash distribution: $200,000
• Year 2 cash distribution: $215,000
• Year 3 cash distribution: $230,000
• Year 4 cash distribution: $245,000
• Year 5 cash distribution: $260,000 + sale proceeds $6,500,000 = $6,760,000

The IRR is approximately 10.4% — the annualized total return including both operating income and sale appreciation.

Levered vs. Unlevered IRR

Unlevered IRR assumes all-cash purchase; measures the property's underlying return.

Levered IRR assumes a mortgage; measures the equity investor's actual return after debt service.

Levered IRR is typically higher than unlevered IRR when the property's return exceeds the cost of debt — a phenomenon called "positive leverage." This is the fundamental reason commercial real estate is acquired with mortgage financing. When cost of debt exceeds property return, leverage destroys equity returns — negative leverage. In high-rate environments, deal underwriting must carefully consider where debt cost sits relative to going-in cap rate.

IRR vs. Other Return Metrics

• vs. Cap Rate: Cap rate is one moment; IRR is the full hold period. A 5.5% cap rate deal could generate a 15% IRR (with leverage and appreciation) or a 7% IRR (without).
• vs. Cash-on-Cash: Cash-on-cash is one year of cash yield on equity. IRR weights all years plus terminal value.
• vs. Equity Multiple: Equity multiple is total dollars returned divided by total dollars invested, unadjusted for time. Both IRR and equity multiple matter — investors prefer high IRR AND high multiple, but the two can diverge.
• vs. NPV: NPV is the present value of cash flows discounted at a chosen rate. IRR is the rate that makes NPV equal to zero. The two are mathematically inverse.

Target IRR Ranges in Florida CRE

• Core (stabilized, low leverage): 7–10% IRR
• Core-Plus (some value-add): 10–13% IRR
• Value-Add: 13–17% IRR
• Opportunistic / Distressed: 17–25%+ IRR
• Development: 20%+ IRR (higher risk; longer execution)

What is a good IRR for commercial real estate?

It depends on the risk profile of the deal. Core stabilized investments target 7–10% IRR; value-add targets 13–17%; opportunistic and distressed target 17–25%+. Higher target IRRs imply higher execution risk; lower target IRRs imply more stable cash flow and lower exit-value uncertainty.

Why use IRR instead of cap rate?

Cap rate measures one moment in time and ignores leverage, appreciation, and the time value of money. IRR captures the full investment lifecycle — operating returns, debt amortization, value appreciation, and sale proceeds — in one annualized number. Sophisticated investors use both; cap rate to price entry and IRR to evaluate the full thesis.

How do I improve a deal's IRR?

Levers include: buy at a lower price (better entry cap rate), grow NOI faster (value-add, rent growth, expense control), increase leverage (when positive leverage available), shorten the hold period (faster value realization), and exit at a lower cap rate (cap rate compression). The most reliable IRR driver is buying right.

Where can I find an IRR calculator for commercial real estate?

Excel's =IRR() function is the standard tool. For Central Florida deal analysis, Michael R. Linton at Linton Global Solutions provides complete underwriting including IRR sensitivity analysis as part of every transaction. Call (312) 612-1031.

Apply Internal Rate of Return (IRR) to Your Florida Deal

Get a free consultation with Michael R. Linton — 39 years of Central Florida CRE transaction experience.