IRR (Internal Rate of Return)

A comprehensive return metric that calculates the discount rate at which an investment's net present value equals zero, accounting for all cash flows including appreciation.

Internal Rate of Return (IRR) is the most comprehensive metric for evaluating investment performance. It accounts for the timing and magnitude of all cash flows—including annual income, appreciation, and eventual sale proceeds. **What IRR Captures:** 1. Initial investment (negative cash flow) 2. Annual cash flows (after debt service) 3. Principal paydown (equity building) 4. Appreciation or depreciation 5. Sale proceeds (exit cash flow) **How IRR Works:** IRR is the discount rate that makes the Net Present Value (NPV) of all cash flows equal zero. Think of it as the "true" annual return accounting for time value of money. **Example:** Year 0: Invest $500,000 Years 1-5: Receive $40,000/year Year 5: Sell for $2,500,000, net $1,800,000 IRR calculation yields ~20% annually (meaning each dollar grows at 20%/year compound) **NNN Investment IRR Drivers:** - Cap rate at purchase vs. exit (compression/expansion) - Annual rent escalations (1-2% typical) - Lease term remaining (more term = more value) - Financing terms (rate, LTV, amortization) - Hold period (typically 5-10 years) **Target IRRs by Strategy:** - Core NNN (investment-grade, long lease): 8-12% - Value-Add NNN (short lease, re-tenant): 12-18% - Opportunistic (distressed, development): 18%+ **Limitations:** - Assumes reinvestment at IRR rate (often unrealistic) - Highly sensitive to hold period assumptions - Multiple IRR solutions possible for complex cash flows - Ignores total dollar return (a $100k profit could have higher IRR than $1M profit)

Related: cash-on-cash-return, cap-rate, noi, equity-multiple