Internal Rate of Return Real Estate Investments
This isn’t the most exciting topic in the world, but if you’re passively investing in real estate syndications, you’ll need to know how to evaluate the projected internal rate of return (IRR).
The quick version is that a higher IRR usually is a better opportunity. But that number alone doesn’t tell the full story. So, even though it’s a boring topic for people who hate math (like me) it’s a good idea to know how to calculate IRR so you know what a sponsor is saying about the opportunity.
This article covers the basics of internal rate of return real estate and how to use it to evaluate syndication opportunities.
What is internal rate of return in real estate?
If you’re used to owning a single-family home as a rental property, you probably haven’t had to do an IRR calculation. But in commercial real estate, the IRR formula is a metric everyone uses to see if the property’s a great opportunity.
Sure, there’s a whole bunch of other real estate numbers you can look at, but an IRR gives a good metric of what’s going on.
Basically, it captures the annual return on a project while also factoring in the time value of money and when you get paid. Because getting $100,000 next year isn’t worth the same as getting it five years from now, and the IRR metric adjusts for that timing.
Why does the internal rate of return matter?
So why does this matter? First of all, every real estate syndication you look at will include the property’s IRR. Second, real estate is a long-term investment, so you need to think about what it means to have your money tied up for years. What’s the opportunity cost of doing that?
Returns might look great on paper, but if you could invest in another syndication or a different type of asset, the internal rate of return helps you compare options and make better investment decisions.
Key parts of internal rate of return in commercial real estate
There are main components of the internal rate of return include:
- Initial investment
- Cash flows
- Timing of cash flows
- Discount rate
- Net present value
Initial capital investment
Before you can start the calculation, you’ll need to know what goes into the upfront investment.
- Property acquisition price: This is pretty straightforward. This is how much we’re going to buy the commercial property for.
- Closing costs: Just like any other real estate deal, you’re going to have costs when you finalize the purchase.
- Due diligence expenses: There’s a lot that goes into due diligence. Some of the costs we often have include hiring people to do a market analysis, traveling to locations, and paying for inspections. All of these add up as part of due diligence.
- Immediate capital improvements: Some properties require you to handle renovations or make improvements right away. We see this in the hotel space where the franchise brand requires new carpeting, furniture, or signage.
All cash flows
Cash flows represent the movement of money in and out of the property.
Cash inflows
Positive cash inflows come from rental income or, in our case, hotel stays. These cash flows should grow annually with market rates. We also capture tax benefits through depreciation deductions and potential tax credits.
Cash flow assumptions use Net Operating Income (NOI), which is revenue minus operating expenses.
Additional income streams could include parking fees, laundry revenue, and storage rentals.
Cash outflows
Outflows include operating expenses like property management fees, maintenance, insurance, taxes, and utilities. Other outflows include capital expenditures for major repairs or improvements and debt service payments.
Exit proceeds
When the property sells, investors receive the net sales price minus selling costs (broker fees, legal expenses, transfer taxes). Market appreciation greatly impacts overall proceeds.
Holding period
Timing is everything. Earlier positive cash flows contribute more to IRR than later ones because of the time value of money. A property that has strong cash flows in years 1-2 will show a higher internal rate of return than one with back-loaded returns, even with identical total returns.
Timing of cash flows
You’ll need to know if cash inflows come monthly, annually, or on some other interval. Here are a few scenarios in commercial real estate investment:
- Tenant turnover or lease renewals: When tenants move out or new ones move in, rental income can drop or increase depending on vacancy periods or new lease terms.
- One-time events: In the hotel space, we see uneven cash flows for one-time events like conferences or large group rentals.
- Expense reimbursements: In triple-net (NNN) leases, tenants reimburse owners for property taxes, insurance, or maintenance, which can change.
- Capital improvements: If the property undergoes upgrades, cash flow may dip temporarily due to capital budgeting costs or reduced occupancy during construction.
- Sale of units or parcels: In mixed-use developments or condo-style commercial projects, income may spike when individual units or sections are sold.
- Refinancing: The real estate syndicator might refinance a property mid-hold, which creates a one-time cash inflow.
Discount rate
The discount rate is the percentage rate used to figure out how much future money is worth today. It’s the rate at which the value of all future cash coming in equals the money spent now. Simply put, it’s the breakeven point in today’s dollars.
If the IRR is higher than your predetermined discount rate, the investment looks good. If IRR is lower, it might not be.
Net present value
Net present value is how much an investment is really worth today by adding up the value of all the money you expect to get in the future. It’s then adjusted for the fact that future value is never as valuable as money in your hand right now.
Types of internal rate of returns in real estate
There are three types of IRR formulas:
- Unlevered IRR: This looks at the return on a property without considering any loans. It shows the pure performance of the investment based only on cash flows from the property itself.
- Levered IRR: This IRR metric involves counting the impact of financing. It shows the return on the investor’s actual cash invested after debt costs, so leverage amplifies gains or losses.
- Modified Internal Rate of Return (MIRR): This IRR function assumes you reinvest earnings at a normal rate, not the project’s own high return. It gives a more realistic number and helps you compare projects more accurately.
How to calculate internal rate of return
Bear with me as I give an example of how commercial real estate investors calculate IRR. Since this is a blog post and most of us use software to automate this step, we’ll go with more of the theory than actual manual calculation. This is from one of our hotels.
Hotel investment property details:
| Item | Value |
| Purchase price | $5,000,000 |
| Down payment | $1,200,000 |
| Loan amount | $3,800,000 |
| Interest rate | 5.2% |
| Loan term | 25 years (commercial amortization) |
| Net Operating Income (NOI) | $600,000 per year |
| Annual debt service | $350,000 |
| Hold period | 8 years |
| Selling price (end of year 8) | $7,800,000 |
| Selling costs (assume 4%) | $312,000 |
| Net sale proceeds (before loan payoff) | $7,488,000 |
Step 1: Calculate annual cash flow before sale
Annual cash flow is NOI – Debt Service
$600,000 – $350,000 = $250,000 per year
Step 2: Loan balance at sale
Assuming a 25-year amortization at 5.2%, the remaining loan balance after 8 years ≈ $3,034,000.
Step 3: Net sale proceeds to equity
Net Proceeds = 7,488,000 – 3,034,000 = 4,454,000
Step 4: Cash flow summary
| Year | Cash flow description | Cash flow ($) |
| 0 | Initial equity investment | –1,200,000 |
| 1–7 | Annual cash flow to equity | +250,000 each year |
| 8 | Annual cash flow + sale proceeds | 250,000 + 4,454,000 = 4,704,000 |
Step 5: IRR calculation
The cash flow stream to equity investors is:
- Year 0: –1,200,000 (initial equity investment)
- Years 1–7: +250,000 per year (annual cash flow after debt service)
- Year 8: +4,704,000 (annual cash flow + sale proceeds)
The cash flow series:
[-1,200,000, +250,000, +250,000, +250,000, +250,000, +250,000, +250,000, +250,000, +4,704,000]
This cash flow series’s internal rate of return is approximately 20.9%.
Step 6: Sensitivity notes
Returns can change quite a bit if the sale price or operating income changes over time. A sensitivity analysis helps see how much the internal rate of return might move if the numbers turn out better or worse than expected.
The table below shows how different sale prices and net cash flow levels would affect the internal rate of return. It gives a quick view of what the results could look like in stronger or weaker market conditions.
| Scenario | Sale price | IRR |
| Best case | $7.8M | 20.9% |
| Sale -10% | $7.02M | 17.2% |
| Sale + 10% | $8.58M | 24.2% |
| NOI + 10% ($660k/year) | 22.4% | |
| NOI – 10% ($540k/year) | 19.3% |
Summary of the property internal rate of return
In our IRR example, this hotel could provide an internal rate of return between 17.2%-24.2%. The range completely depends on inputs like future cash flows, how long the investment period ends up being, and the disposition price at exit.
Reality is, IRR isn’t set in stone, and the hotel could do better or worse than our projections, which is why you’ll want to see other details like due diligence and market research.
Internal rate of return real estate red flags
There’s always many sides to every story, so if you’re looking at an IRR for an investment property, you should know that it’s not the be-all and end-all. Here are some red flags you should look at and consider when you’re looking at potential investments.
Assumes reinvestment at IRR: IRR assumes you reinvest all interim cash flows at the same rate as the IRR, which may not be realistic. In reality, reinvestment rates are often lower.
Multiple IRRs: Complex projects with irregular cash flows can have multiple IRRs which makes it confusing to interpret which is the right one.
Ignores project scale: IRR doesn’t account for the size of the investment. A smaller deal with a higher IRR might be less profitable overall than a larger deal with a lower IRR.
Timing sensitivity: IRR is sensitive to the timing of all the cash flows. Changing when cash flows happen can greatly change IRR, even if total returns are similar.
Overemphasis on short-term gains: IRR can indicate that a property investment with high returns is the right choice, but it may miss long-term value and stability.
Does not reflect risk: IRR ignores risks or uncertainties in the cash flows, which should be a part of any investment analysis.
Evaluating real estate syndications based on internal rate of return
The challenge when you are looking at opportunities is that the internal rate of return is one of the key metrics that you’ll see. There might be some other numbers that a syndicator lists, but most of the time, it’s about projected IRR. So how do you decide if a potential real estate investment is the right fit for you?
So how do you decide if a deal is right for you? Here’s how I approach it.
Start with the IRR
Start with the projected IRR because it’s one of the fastest ways for comparing investments. A strong IRR helps you quickly identify which deals might deserve a closer look.
Review the details of the deal
Once I’ve filtered deals based on IRR, I look specifically at what’s being offered. My checklist looks like this:
- Due diligence: What kind of research and underwriting went into the deal? Are the projections realistic
- Capital stack: What are the financing details? Is the debt long-term or short-term? What’s the leverage ratio?
- Distributions and waterfalls: How and when will returns be paid? How are profits split between investors and the sponsor? Is there an alignment in incentives?
- Sponsor track record: What experience does the sponsor have? Have they managed similar assets successfully?
- Communication: How transparent is the sponsor? Will you receive consistent updates?
- Technology: What system or portal is used to track your investment and updates?
Benchmarks for internal rate of return in real estate investment
If you want to get an idea of what’s a good IRR, Inegra Realty’s Viewpoint 2025 report shows the following benchmarks by strategy:
Core / stabilized properties: These are fully leased, low-risk assets in strong markets that have steady income. Typical IRR: 6–9%
Core-plus investments: Slightly higher risk with minor improvements or leasing upside. Typical IRR: 12–16%
Value-add opportunities: Underperforming properties that need renovations or repositioning to create higher returns. Typical IRR: 15–20%
Opportunistic deals: High-risk, high-reward projects like new development or major redevelopment. Typical IRR: 20%+
Final thoughts on using IRR for property investment
There are a lot of different metrics you’ll hear in real estate, and the best advice is not to treat any of them as stand-alone validation. The internal rate of return is a good starting metric, but it should be just one piece of your overall decision criteria.
Now, since this is my blog, I’ll do a quick shameless plug. If you want to learn more about passive hotel investments, check out our Barcelona Hotel Fund offering here.
Internal rate of return real estate: FAQs
What does a 20% IRR mean?
A 20% IRR means that the syndicator projects the real estate investment to grow by 20% per year on average during the time you hold your investment.
What is the 7% rule in real estate?
The 7% rule says that the property’s gross annual rent should be at least 7% of the purchase price. For example, if a property costs $400,000, it should generate about $28,000 per year in rent ($400,000 × 0.07), or roughly $2,333 per month.
How to calculate IRR on real estate?
To calculate IRR on real estate, list all cash flows and find the discount rate that makes their net present value zero. You can do this using Excel’s IRR function with your cash flow data.
The information in this post is for informational purposes only and should not be considered tax or legal advice. Please consult with your own tax professionals and advisors before making any decisions or taking action based on this information.
