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What is IRR?

What is IRR?

The Internal Rate of Return (IRR) is the rate at which each invested dollar you invest is projected to grow for each period it is invested. IRR differs from other metrics, such as absolute return, in that it accounts for the concept of the “time value of money," the fact that each dollar received and reinvested today is worth more than a dollar received and reinvested next year. IRR is one of the best ways for an investor to compare various investments based on their yield while holding other variables constant.

What IRR tells you

IRR is useful because it is one way to provide an “apples-to-apples” comparison between different investments, especially if they have different distribution timing. Since IRR is uniform for different kinds of investments, you can use it to rank different opportunities on a relative basis.

IRR limitations

One of the issues with relying solely on IRR is that it can be misleading if used alone. How an investor derives IRR also is an important consideration when comparing real estate investment opportunities. Although a higher IRR might look good at face value, investors need to look below the surface to understand the terms and assumptions used to derive IRR and consider their desire for operational distributions. That is why investors often use IRR in conjunction with other metrics when analyzing the merits of a particular real estate investment offering.

IRR vs. ROI

IRR is not the same as Return on Investment, or ROI. ROI reflects the total growth of an investment over time, whereas IRR shows the investment's annual growth rate. This means the investment may not have the same IRR each year.

 

If you would like to learn more about IRR, find the full article here