What is IRR in commercial real estate?
The return that accounts for when each dollar arrives, not just how many. Which makes it the most complete single number in underwriting and the one most dependent on a guess about the future.
What it actually is
Line up every cash flow in a deal: the equity going out at the start, the cash coming back each year, and the net proceeds when you sell. IRR is the annual rate at which those flows exactly cancel out.
The useful property is that it accounts for timing. A dollar in year one and a dollar in year five are not the same dollar, and IRR is the only common measure that says so — cap rate looks at a single year and cash-on-cash looks at a single year of your equity.
Timing matters, but less than you would think
Sample inputs
- Purchase price
- $16,750,000
- Total equity
- $6,195,000
- Loan
- $10,890,000 @ 6.50%
- Hold
- 5 years
- Total NOI over hold
- $6,250,000
- Selling costs
- 6%
One deal, two income profiles. Identical total NOI across the five-year hold, identical exit, identical debt — only the order in which the income arrives differs.
| Income profile | Total NOI | Levered IRR |
|---|---|---|
| Best year first, declining | $6,250,000 | 11.928% |
| Worst year first, rising | $6,250,000 | 11.667% |
| Difference | none | 0.26 points |
Front-loading wins, which is what IRR is for: money sooner is worth more. But the whole effect of reversing every year of the hold is 0.26 points.
That is a smaller number than most people expect, and it sets up the one that matters.
The exit is doing almost all the work
Hold the income, the debt and the hold period exactly as they are, and change only the cap rate you assume a buyer pays at the end.
| Exit cap | Sale value | Levered IRR |
|---|---|---|
| 6.75% | $17,680,000 | 7.577% |
| 7.00% | $17,048,571 | 5.874% |
| 7.25% | $16,460,690 | 4.176% |
| 7.50% | $15,912,000 | 2.476% |
| 7.75% | $15,398,710 | 0.768% |
A hundred basis points on the exit cap moves IRR 6.81 points — from 7.577% to 0.768%. Re-ordering the entire hold moved it 0.26.
The exit assumption is roughly twenty-six times as powerful as everything that happens during the hold put together. And it is the one input nobody can know, because it is a claim about what a stranger will pay several years from now.
Which is the practical takeaway: an IRR quoted without its exit cap rate is not a number you can evaluate. It is the first thing to ask for and the first thing to stress — run the deal at a flat exit cap and see whether it still clears.
What IRR will not tell you
How much money you made. A 20% IRR on $200,000 of equity held eighteen months and a 14% IRR on $6 million held seven years are not comparable outcomes. Read the equity multiple beside it.
Whether the reinvestment assumption is realistic. The maths behaves as though interim distributions earn the IRR itself, which flatters deals with large early cash returns.
Whether your numbers are right. IRR is exquisitely sensitive to the exit and the exit rests on forward NOI, which rests on the rent roll. A precise IRR built on a rent roll nobody checked is precision without accuracy — which is why everything here is derived from the leases.
Questions people ask
What is IRR in commercial real estate?
The annualised rate of return that makes the present value of every cash flow in a deal — the equity you put in, the cash you take out each year, and the net proceeds at sale — come to zero. In plain terms, it is the return rate that accounts for when each dollar arrives, not just how many arrive.
How is IRR different from cash-on-cash return?
Cash-on-cash is one year's cash divided by your equity. It says nothing about the sale, about loan amortization, or about years two through five. IRR takes the whole hold including the exit, which makes it more complete and much more dependent on assumptions about the future.
What is a good IRR?
There is no number we can give you that would be honest. It depends on your cost of capital, the risk of the specific deal and what else you could do with the money. Anyone quoting a universal threshold is describing their own situation, not yours.
Why can IRR be misleading?
Because it is dominated by the exit, and the exit is the least knowable thing in the model. On the deal below, re-ordering the entire hold moves IRR a quarter of a point; a 100 basis point move in the exit cap rate moves it nearly seven. An IRR quoted without its exit assumption is close to meaningless.
Does IRR assume I reinvest the cash flows?
Mathematically it behaves as though interim cash is reinvested at the IRR itself, which is usually optimistic. It matters most on deals with large early distributions, and it is one reason equity multiple is worth reading beside IRR rather than instead of it.
Keep reading
IRR calculator
Run your own cash flows. Free, no signup.
Cap rate vs cash-on-cash
The two single-year measures, and how they differ.
Exit cap rate explained
The assumption that dominates the answer.
Exit & sale modeling
How the product builds the figure IRR rests on.
Test assumptions
Run the exit both ways and see what moves.
Cash-on-cash return
The simpler measure, and what it leaves out.
See what your IRR is actually resting on.
Model the hold from the rent roll, then move the exit cap and watch what happens. If the deal only works with compression, better to find out now. Free plan, no credit card.