How the Internal Rate of Return Benefits Real Estate Investors
Internal Rate of Return is one of the more popular rates of return used by real estate investors and other analysts as a measurement of rental income property profitability.
What makes it popular is that the internal rate of return (IRR) accounts for the time value of money, and therefore it provides investors with a linkage between both the present value (PV) and the future value (FV) of an real estate investment property's income stream.
The IRR Concept
Since the investor is making the investment with money that has a particular buying power today, investors can use IRR to determine their rate of return on their initial cash investment, based not upon what those future cash flows may be worth tomorrow, but rather on what a property's estimated future cash flows are also worth today.
In other words, the internal rate of return is that rate at which all tomorrow's incomes are discounted to exactly equal the amount of money initially invested today.
Needless to say, trying to manually make the IRR calculation would require a good deal of time, and maybe for most of us, a mathematical impossibility. So here are a couple of more realistic ways to consider using for the computation.
- A financial calculator like HP12. In this case, open the instruction manual and read along to make the necessary keyboard selections. Somewhat tedious.
- MS Excel. The popular spreadsheet software program includes the IRR function. Not difficult if you have some understanding of Excel.
- Pro RE Calculator. Our online suite of sixty-two real estate calculators includes an IRR calculation. Very easy.
Rule of Thumb
By itself the internal rate of return is not enough to sign on the dotted line. There are many other factors to consider like economic and market area trends, financing, structural condition and location, income tax implications, as well as a host of other prudent real estate investing due-diligence practices.
Moreover, one-size doesn't fit all. Whereas one investor might find some rate of return appealing, another might have no interest whatsoever. It depends on the investor's particular objective and how it might stack up to other investment opportunities available. But you get the idea.
So You Know
ProAPOD's real estate investing software solutions (Agent 6 and Executive 10) and it's suite of online real estate calculators (Pro RE Calculator) each compute the internal rate of return.