Internal rate of return, and what it hides

Internal rate of return is the discount rate at which the net present value of all cash flows equals zero. In plain terms, it is the annualized return that accounts for when money arrives, not just how much.

That is a genuine improvement over cash-on-cash, which ignores timing entirely and says nothing about the sale.

It is also the number most easily engineered, and syndication offering documents are full of engineered examples.

What IRR actually captures

A deal that returns your money in year two is better than one that returns the same money in year seven. IRR reflects that. Simple return multiples do not.

It also incorporates the exit, which for most real estate is where the majority of the return lives. A property producing modest cash flow and a large sale gain has a very different profile from one producing steady cash and no appreciation, and only IRR captures both in one number.

The three assumptions that determine everything

The exit cap rate. The single most consequential input in any real estate model.

A model exiting at a cap rate below the entry cap — cap rate compression — is forecasting that future buyers will accept a lower yield. That is a bet on interest rates and market sentiment, not on the property.

Change the exit cap from five and a half to six and a half percent, and a projected eighteen percent IRR can fall into single digits without a single operational assumption changing.

Any model that does not show you the IRR at a range of exit caps is hiding the most important variable.

Rent growth. Compounded over a five- or ten-year hold, small differences produce large ones.

Three percent annual rent growth over ten years is a thirty-four percent increase. Five percent is sixty-three percent. The second model produces a much higher IRR and reflects a forecast, not an analysis.

Compare the assumed growth rate against the market's actual long-run history and against local wage growth, which ultimately constrains it.

The hold period. IRR is sensitive to it in ways that are not intuitive.

A deal with a large early gain shows a spectacular IRR over a short hold and a mediocre one over a long hold, even though the long hold produces more total money.

The reinvestment problem

A technical point with practical consequences.

IRR mathematically assumes that all interim cash flows are reinvested at the IRR itself. If a deal projects a twenty percent IRR, the math assumes every distribution is redeployed at twenty percent.

In reality, distributions sit in a bank account or go into deals with lower returns. Which means realized returns are typically below the projected IRR even when the deal performs exactly as modeled.

Modified internal rate of return addresses this by specifying a realistic reinvestment rate. It produces lower and more honest numbers, which is presumably why it appears less often in marketing material.

Equity multiple, and why it belongs alongside

Equity multiple is total cash returned divided by total cash invested. A 1.8x multiple means you got back $1.80 for every dollar.

It ignores timing entirely, which is its weakness and, paired with IRR, its usefulness.

Two deals can both show a fifteen percent IRR. One returns 1.4x over three years, the other 2.2x over seven. Same IRR, very different amounts of money.

Always look at both. A high IRR with a low multiple means a quick, small win — which is fine if you have somewhere to put the money next, and considerably less useful if you do not.

How offering documents flatter the number

Aggressive rent growth. Exit cap compression. Expense growth assumed below rent growth, which is rarely true. Optimistic vacancy. Capital expenditure understated or omitted from cash flows. Refinance proceeds included as a distribution, which boosts early cash flow and increases leverage. Fees excluded from the investor-level calculation.

None of these is fraudulent. All of them shift the number.

What to ask for

A sensitivity table showing IRR across a range of exit cap rates and rent growth assumptions. If it is not provided, request it. Refusal is informative.

The downside case, and specifically what happens at zero rent growth and an exit cap a full point above entry.

Net IRR to the investor after all fees and promotes, not gross deal-level IRR.

The equity multiple alongside.

The assumptions listed explicitly, with sources.

The honest use

IRR is a comparison tool between deals modeled on consistent assumptions. It is not a prediction.

Used to rank opportunities you have underwritten yourself, with your own assumptions applied identically, it is genuinely useful.

Used to evaluate someone else's projection, it tells you about their assumptions rather than about the property.

General information about real estate analysis, not investment advice. Projected returns are estimates and actual results may differ substantially. Consult qualified professionals about your own circumstances.