CRE glossary
Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is the annualized discount rate at which the net present value (NPV) of all a deal's cash flows — the initial equity outlay, interim distributions, and the sale proceeds — equals zero. It is a time-weighted return that accounts for both the size and the timing of every cash flow.
Formula
0 = Σ [ CFₜ ÷ (1 + IRR)ᵗ ] for t = 0 to n (solve for IRR; CF₀ is the initial equity outflow, negative)
How IRR is used in CRE underwriting
IRR is the headline return metric on nearly every commercial real estate deal because it collapses a multi-year, uneven cash-flow stream — acquisition equity out, quarterly or annual operating distributions in, and a lump-sum reversion at sale or refinance — into a single annualized percentage. Because the equation has no closed-form solution, IRR is found iteratively (Excel's XIRR/IRR, or a solver), which is why a deterministic calc engine matters: the same cash flows must always resolve to the same rate.
- •Deal-level (project or unlevered/levered) IRR measures the return on total invested equity before the promote split.
- •Partner-level IRR (LP IRR, GP IRR) is computed after the equity waterfall allocates preferred return, catch-up, and promote.
- •Use XIRR (date-based) rather than IRR (period-based) whenever cash flows land on irregular dates — mid-month closings and quarterly distributions rarely fall on clean annual periods.
Why IRR matters — and what it hides
IRR rewards getting capital back sooner: a dollar distributed in year 1 lifts IRR far more than the same dollar in year 5. That time-sensitivity makes IRR the natural yardstick for comparing deals with different hold periods and distribution timing, and it is the metric most LP agreements tie the promote hurdle to. But IRR is a rate, not a dollar amount — it says nothing about how much total profit a deal produces, and it can be gamed by a quick flip or an early cash-out refinance that spikes the rate while returning little absolute capital.
- •Always pair IRR with the equity multiple (total dollars returned per dollar in) — a 30% IRR on a 14-month flip may return less profit than an 18% IRR held five years.
- •IRR assumes interim distributions are reinvested at the IRR itself, which overstates returns on very high-IRR deals; MIRR corrects this with an explicit reinvestment rate.
- •A short hold can inflate IRR; a longer hold with strong cash flow can look weaker on IRR yet deliver more wealth.
Common pitfalls and nuances
IRR breaks down in a few well-known ways. When a cash-flow stream changes sign more than once — for example a deal that requires a mid-hold capital call after distributions begin — the polynomial can have multiple mathematically valid IRRs, and software may report whichever it finds first. Deals with no early outflow after year 0 or with all-positive flows can return no real IRR at all. And because IRR is time-weighted, it is sensitive to exactly when you model the sale, so a 25-bps shift in exit cap rate or a one-quarter delay in disposition can move the number materially.
- •Non-conventional (sign-changing) cash flows can produce multiple IRRs — check with NPV or use MIRR.
- •IRR is exquisitely sensitive to exit-year assumptions; stress-test it with a two-variable sensitivity table on exit cap rate and hold period.
- •Never compare IRR across deals without also checking hold period, equity multiple, and cash-on-cash — the rate alone is not decision-ready.
Worked example
A sponsor invests $2,000,000 of equity to acquire a multifamily asset. The deal distributes $120,000 in year 1, $140,000 in year 2, $160,000 in year 3, $180,000 in year 4, and in year 5 pays $200,000 of operating cash plus $2,900,000 of net sale proceeds ($3,100,000 total). The cash-flow stream is: −$2,000,000 (Y0), +$120,000, +$140,000, +$160,000, +$180,000, +$3,100,000. Solving 0 = Σ CFₜ ÷ (1+IRR)ᵗ gives an IRR of roughly 14.5%, with a 1.85x equity multiple ($3,700,000 returned ÷ $2,000,000 in). If the same $3.1M reversion instead arrived in year 3 (a faster exit), the IRR would jump to roughly 20% even though total dollars returned fall — illustrating how timing, not just profit, drives the metric.
Frequently asked questions
- What is a good Internal Rate of Return (IRR) in commercial real estate?
- It depends on strategy and risk. Stabilized core deals often target a 10–13% levered IRR, value-add multifamily and repositioning plays commonly underwrite to 14–18%, and ground-up development or opportunistic deals aim for 18%+ to compensate for execution and lease-up risk. There is no universal threshold — an IRR is only 'good' relative to the deal's risk, hold period, and the returns an LP could earn elsewhere.
- What is the difference between IRR and equity multiple?
- IRR is a time-weighted annual rate that penalizes capital tied up longer, while the equity multiple (total cash returned ÷ total equity invested) is a simple dollars-out-per-dollar-in ratio that ignores timing entirely. A short-hold deal can post a high IRR with a low multiple, and a long-hold deal the reverse, so sponsors and LPs almost always evaluate both together.
- Why does my deal show two different IRRs?
- When a cash-flow stream changes sign more than once — typically because a mid-hold capital call or negative year follows earlier distributions — the underlying polynomial can have multiple real roots, each a valid IRR. This is a known limitation of the metric. Use NPV at your target discount rate or a modified IRR (MIRR) with an explicit reinvestment rate to get a single, decision-usable figure.
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