Internal Rate of Return Calculator
An asset's internal rate of return, or IRR, measures the annual growth rate expected to be generated by an investment. Calculate yours today.
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To calculate the internal rate of return (IRR), which is a measure of an investment's profitability, we need to know the initial investment, investment return, and time period. The initial investment is the amount of money you put into an investment at the outset, while the investment return is the total amount of money earned from the investment over a given period. In this case, we have an initial investment of $1,450,000 and an investment return of $1,550,000 over a time period of 12 months. Using these values, we can calculate an IRR of 6.90%.
Internal Rate of Return (IRR)
In multifamily real estate investment, the internal rate of return (IRR) is a key metric used to assess the potential profitability of a property. It represents the annual rate of growth that an investor can expect to earn on their investment.
IRR takes into account both the timing and amount of cash flows associated with an investment, as well as the time value of money. The higher the IRR, the more profitable the investment is expected to be.
How to Calculate IRR
IRR is typically calculated using a discounted cash flow analysis, which takes into account the time value of money. The basic formula for calculating IRR is below:
The variables are explained below.
Variable | Definition |
|---|---|
NPV | Net present value of the cash flows |
C | Cash flow (for a given time) |
t | Time period |
r | Internal rate of return |
In a discounted cash flow analysis, the internal rate of return is the discount rate that makes the net present value (NPV) of an investment equal to zero — accounting for the time value of money.
It's not the simplest of calculations to do on pen and paper — so I'd recommend using the calculator higher up on this page.
An Example of an IRR Calculation
Let's walk through a calculation to illustrate how IRR works. Robert is looking to buy a multifamily property valued at $4 million. He plans to hold the property for five years and expects to receive the following annual cash flows from the property, including rents and other sources:
- Year 1: $200,000
- Year 2: $220,000
- Year 3: $240,000
- Year 4: $260,000
- Year 5: $300,000
In addition to the purchase price, Robert will incur $300,000 in initial acquisition costs in the form of closing costs and other fees. He anticipates selling the property for $5 million at the end of year 5.
To calculate the IRR for this investment, we can use an online IRR calculator or a spreadsheet software like Microsoft Excel. Using the above metrics, the IRR for this investment is approximately 14.7%.
This means that our fictional Robert can expect an annualized rate of return of 14.7% on his investment over the five-year holding period. This IRR can be compared to other potential investments to help him determine whether this particular multifamily property is a good investment opportunity.
Other Measures
There are some other related calculations and metrics used alongside IRR. Read more about them below.
Modified Internal Rate of Return (MIRR)
A modified internal rate of return, or MIRR, is a variation of IRR that takes into account the reinvestment of any positive cash flows into a different asset.
MIRR calculations utilize the investor’s estimated rate of return on the reinvested funds to determine the “reinvestment rate”. This rate is then used to calculate a “modified” IRR which more accurately represents the investor’s overall return.
MIRR can be particularly useful when the cash flows from an investment are expected to be reinvested at a different rate of return than the initial investment.
Return on Investment (ROI)
Return on investment, or ROI, is another commonly used measure of investment profitability. Unlike IRR, which measures the annual rate of growth, ROI represents the overall percentage increase or decrease in the value of an investment over its lifespan.
ROI does not take the time value of money into account, and therefore it may not provide as accurate a picture of the profitability of an investment as an IRR calculation would.
Conclusion
IRR is a crucial metric in evaluating the potential profitability of multifamily real estate investments. While it can be calculated using a formula and iterative process, our online IRR calculator makes the process easier.
MIRR and ROI are other measures that can provide additional insights into investment performance, but they do not often provide as complete a picture as IRR.