Internal Rate of Return is an annualized measure derived from the timing of equity cash flows. It is calculated by solving for the discount rate that equates the present value of all future equity distributions with the initial capital invested.
In real estate, IRR moves primarily with timing.
What IRR Actually Measures
IRR incorporates every equity cash flow: the initial investment, interim distributions, refinance proceeds, and sale proceeds. Cash received earlier shortens the period capital is exposed. Cash received later extends it.
Assume an equity investment of $500,000.
In one structure, $250,000 is returned in year three and $750,000 is returned at sale in year ten. Total cash returned is $1,000,000, producing a 2.0x equity multiple. The IRR solves for the rate that satisfies:
The resulting IRR is approximately 9.4 percent.
Now hold the total outcome constant and change only the timing. Assume the full $1,000,000 is returned at sale in year ten:
The resulting IRR is approximately 7.2 percent.
The difference is timing.
Impact of Execution Delays
IRR responds sharply to delays in capital recovery.
Using the first structure, move the $250,000 distribution from year three to year five while leaving the sale proceeds unchanged:
The IRR falls to approximately 8.3 percent.
A two-year delay reduces the annualized return by more than 100 basis points without any change to exit value. Leasing friction, renovation overruns, and refinancing slippage all enter the calculation the same way: capital remains at risk longer than planned.
Leverage and IRR
Leverage alters IRR by changing how much equity is exposed and for how long.
Assume a property is purchased for $2,000,000 and sold for $2,500,000 in year ten.
With $1,000,000 of equity invested and no interim distributions:
The IRR is approximately 4.1 percent.
Now assume the same property is financed with $500,000 of equity, producing the same $500,000 of net profit at sale:
The IRR increases to approximately 7.2 percent.
The property outcome is unchanged. The equity exposure is not.
Refinancing and IRR
Refinance proceeds affect IRR by returning capital earlier in the hold. Partial recovery of equity shortens exposure and changes the annualized result.
Refinancing depends on income at the time of the event, interest rates, and lender constraints. When refinance proceeds are embedded without stress testing, IRR becomes dependent on future capital market conditions rather than executed performance.
IRR becomes more informative when refinance timing and proceeds are modeled conservatively and delayed scenarios are tested explicitly.
Where IRR Can Be Unreliable
IRR assumes interim cash flows can be reinvested at the same rate. In practice, reinvestment opportunities rarely match modeled returns.
IRR also struggles to compare investments of different sizes. Smaller deals can show higher IRRs while producing far less total profit. Short hold periods and early distributions can further inflate IRR while limiting long-term value creation.
These limitations require context, not adjustment.
How IRR Is Used Effectively
IRR is most useful as a diagnostic metric. It highlights sensitivity to timing, leverage, refinancing, and exit assumptions. It exposes where returns depend on early execution or favorable capital markets.
When evaluated alongside equity multiple, cash-on-cash returns, DSCR, and liquidity analysis, IRR helps clarify tradeoffs. Used alone, it obscures them.
Conclusion
IRR reflects how long equity capital remains exposed and how quickly it is returned. In real estate, exposure duration determines sensitivity to operating variance, financing conditions, and market cycles. Returns that arrive earlier reduce that exposure. Returns that arrive later require compensation for carrying it longer.