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IRR - Internal Rate of Return
Internal rate of return (IRR) is generally more popular than other rates of return to a real estate investor because it calculates for time value of money and provides a linkage between present value (PV) and future value (FV) of any benefit stream.
In other words, IRR allows the investor to take into account both the timing and the scale of cash flows generated by the income-producing investment property.
The principal assumption, of course, is that a dollar in hand today is preferable to a dollar at the end of the year or ten years from now. IRR measures future cash flows with a particular discount rate (an investors desired rate of return) and determines what that is worth today.
Trying to calculate IRR manually is not very practical for income property investors (or anyone else) because the internal rate of return calculation involves tedious mathematical solutions that take a lot time. Even the most skilled investment real estate specialist probably wouldn't know the internal rate of return formula and instead would use a time value calculator or real estate software program to compute it.
So I'll ignore the actual formula (it can be found in other places on the web) and instead resort to a simple example.
Let's suppose you have $100,000 to invest in a rental income property and plan to hold it for five years. Moreover, during the period of those years you plan on receiving five annual cash flows and then an amount of additional money from the sale of the property. When you find the unique rate that discounts the sum of these future cash flows until it equals the initial investment, you will have the IRR.
ProAPOD® Real Estate Investment Software computes internal rate of return in real time automatically as you enter the property data. The IRR is recalculated each time you make changes so it is always accurate. Reports such as the proforma income statement and assumptions include IRR.
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