CRE 101 · deweyluong.realtor

IRR Explained: Internal Rate of Return for Georgia Commercial Real Estate Investors

A property can show a thin first-year return and still be the right buy — or show a dazzling projected return and be a trap. The difference is whether you are looking at one year, or at the whole hold. By Túy “Dewey” Luong, CCIM — Founding Broker, SERHANT. Atlanta · 318 closed sales / $281.2M career volume · 678-707-2498

IRR — internal rate of return — is the measure that looks at the whole hold: the equity you put in, every year's cash flow, and the net proceeds when you sell. It is the headline number in almost every institutional offering memorandum, and the most easily manipulated one. This page shows the mechanics with a full cash-flow table you can check line by line, then the traps to look for before you believe anyone's IRR — including mine. It completes the return trio started in cap rate and NOI and cash-on-cash return.

What IRR actually measures

• One rate for the whole deal: IRR is the annual rate at which the present value of everything you will receive equals the equity you put in. If the IRR is 8%, the deal's cash flows are equivalent to earning 8% a year, compounded, on the money you have in it.
• Timing is the point: a dollar of cash flow in year one counts for more than a dollar in year five. That is why two deals with identical total profit can have very different IRRs — the one that returns money sooner wins.
• The sale is inside the number: unlike cap rate (one year, no loan) and cash-on-cash (one year, with loan), IRR includes rent growth, loan paydown and the exit. It is a hold-period measure, not a snapshot.
• Levered vs unlevered: unlevered IRR runs the property's cash flows against the full price. Levered IRR runs the after-debt cash flows against just your equity — the number that describes your money.

Worked example. The numbers below are made up and rounded to teach the mechanics. This is not a real property.

• A made-up Gwinnett retail property is priced at $1,600,000 with year-one NOI of $96,000 — a 6.0% cap rate. NOI grows 3% a year: $96,000, $98,880, $101,846, $104,902, $108,049 in years one through five.
• Sale at the end of year five, priced on year-six NOI of $111,290 at a 6.5% exit cap rate: gross price about $1,712,159, less 3% selling costs, net sale proceeds about $1,660,794.
• Unlevered IRR: about 7.0%. Total cash in over the hold is about $2,170,471 on $1,600,000 out — an equity multiple of about 1.36x. Note how far that sits from the 6.0% cap rate: the growth and the exit are doing real work.
• Now add the loan: 65% of price ($1,040,000) at 6.5% interest, 25-year amortization — about $7,022 a month, $84,266 a year. Your equity is $560,000. Year-one cash flow after debt service is about $11,734 — a cash-on-cash return of only 2.1%, because the loan rate (6.5%) is above the cap rate (6.0%). Year one is negatively leveraged.
• Levered IRR: about 7.9%. The later years recover what year one gives up: the NOI grows against a fixed payment, you pay the loan down to about $941,847 by the sale, and the equity receives about $718,947 of the net sale proceeds after the loan is repaid. Total equity returned is about 1.44x. The lesson is not that leverage is good or bad — it is that a year-one snapshot (2.1%) and a hold-period measure (7.9%) can describe the same deal, and a buyer who screens on the snapshot alone walks away from it.
• Sensitivity — the exit cap is the whole ballgame: reprice the exit at a 7.0% cap rate instead of 6.5% and the gross sale price falls to about $1,589,862; the unlevered IRR drops to about 5.7%. Half a point of exit cap cost 1.3 points of IRR. Any IRR presented to you embeds someone's guess about the exit — ask for it.

IRR next to the other return numbers

• Cap rate (NOI ÷ price): one year, no loan. Screens value; says nothing about your money or your hold.
• Cash-on-cash (year-one cash flow after debt ÷ equity): one year, with loan. Screens first-year income; blind to growth, paydown and exit.
• Equity multiple (total returned ÷ equity in): the whole hold, but no clock — 1.44x over five years and 1.44x over ten are the same multiple and very different deals. Quote it next to IRR, never instead of it.
• Debt yield and DSCR: the lender's side of the same table — they decide whether the loan that produces your levered IRR is available at all.

The traps inside an IRR number

• The reinvestment assumption: IRR math assumes every interim dollar is reinvested at the IRR itself. Deals that throw off cash early get flattered; that is a property of the formula, not of the building.
• Multiple IRRs: if the cash flows change sign more than once — a development deal with later capital calls is the classic case — the equation can have two answers or none. On sign-changing deals, lean on the equity multiple and total profit instead.
• No sense of scale: 20% IRR on $50,000 for a year is $10,000. 12% on $1,000,000 for seven years is real money. IRR ranks percentages; wealth is counted in dollars.
• A borrowed exit: an exit cap below the going-in cap, year-six NOI built on unsigned leases, or selling costs left at zero — each one quietly inflates the headline. Rebuild the exit before you repeat the number.

Cho nhà đầu tư người Việt

Nhiều nhà đầu tư người Việt tại Metro Atlanta và Gwinnett chỉ nhìn cap rate hoặc cash-on-cash năm đầu rồi bỏ qua những thương vụ tốt — hoặc ngược lại, tin vào con số IRR dự phóng trong tài liệu chào bán mà không kiểm tra giả định đằng sau. IRR đo toàn bộ kỳ nắm giữ: vốn bỏ ra, dòng tiền mỗi năm, và tiền bán ròng cuối kỳ. Trong ví dụ trên, cùng một tòa nhà có cap rate 6,0%, cash-on-cash năm đầu chỉ 2,1% (vì lãi vay 6,5% cao hơn cap rate), nhưng IRR sau vay đạt khoảng 7,9% nhờ tiền thuê tăng trưởng, phần gốc vay được trả dần, và khoản tiền bán ở năm thứ năm.

Điểm cần kiểm tra khi ai đó đưa cho bạn một con số IRR: exit cap rate họ dùng là bao nhiêu so với cap rate lúc mua, NOI năm bán có dựa trên hợp đồng thuê đã ký hay chỉ là dự phóng, và hệ số nhân vốn (equity multiple) đi kèm là bao nhiêu. IRR cao mà không kèm equity multiple và tổng lợi nhuận bằng đô la thì chưa phải là một bức tranh đầy đủ. Đây là thông tin giáo dục chung, không phải tư vấn đầu tư, pháp lý hay thuế.

Frequently asked questions

What is IRR, in plain English?

IRR — internal rate of return — is the single annual rate that makes all of a deal's cash flows, in and out, worth exactly what you paid. You put equity in at the start, you collect cash flow each year, and you collect the net sale proceeds at the end. IRR blends all of that into one annualized percentage that accounts for when the money moved, not just how much. In the worked example on this page, $560,000 of equity produces modest yearly cash flow and a large check at the year-five sale, for a levered IRR of about 7.9%.

How is IRR different from cap rate and cash-on-cash return?

Cap rate looks at one year of income with no loan in it: NOI divided by price. Cash-on-cash looks at one year with the loan in it: year-one cash flow after debt service divided by the equity. Neither one sees rent growth, principal paydown, or the sale. IRR sees the whole hold — every year's cash flow plus the exit — which is why the same property can show a 6.0% cap rate, a 2.1% first-year cash-on-cash, and a 7.9% levered IRR at the same time. They are three different questions, not three competing answers.

Why does the exit cap rate change IRR so much?

Because for most five-year holds, the sale is the biggest single cash flow — often more than all five years of rent checks combined. In the worked example, pricing the exit at a 6.5% cap rate produces an unlevered IRR of about 7.0%; pricing the same building's exit at a 7.0% cap rate cuts the sale price by roughly $122,000 and drops the unlevered IRR to about 5.7%. A seller's pro forma that assumes an exit cap lower than today's going-in cap is quietly assuming the market will pay more for the income later than you are paying now. Underwrite the exit at or above the going-in cap unless you have a specific, documented reason not to.

What are the traps in an IRR number?

Four. First, IRR assumes interim cash flow is reinvested at the IRR itself, which flatters deals with big early distributions. Second, a deal whose cash flows flip sign more than once — common in development, with later capital calls — can have more than one IRR or none. Third, IRR says nothing about scale or duration: a 20% IRR on $50,000 for one year is $10,000 of profit, and it can rank above a 12% IRR that makes $400,000 over seven years. That is why professionals quote IRR next to the equity multiple and the total profit. Fourth, IRR is only as honest as the exit assumption inside it, so always ask what exit cap and what year-six NOI produced it.

Tỷ suất hoàn vốn nội bộ (IRR) là gì và khác gì với cap rate?

IRR là tỷ lệ phần trăm hằng năm tính trên toàn bộ dòng tiền của một thương vụ: vốn tự có bỏ ra ban đầu, tiền thuê ròng nhận được mỗi năm, và số tiền bán ròng ở cuối kỳ. Cap rate chỉ nhìn một năm thu nhập và không tính khoản vay; cash-on-cash chỉ nhìn năm đầu tiên sau khi trả nợ. Trong ví dụ trên trang này, cùng một tòa nhà cho ra cap rate 6,0%, cash-on-cash năm đầu 2,1%, nhưng IRR sau vay đạt khoảng 7,9% vì IRR tính cả tăng trưởng tiền thuê, phần gốc đã trả dần, và khoản tiền bán ở năm thứ năm. Điểm cần kiểm tra: IRR rất nhạy với cap rate lúc bán — giả định exit cap thấp hơn cap rate lúc mua là đang giả định thị trường sẽ trả giá cao hơn trong tương lai. Đây là thông tin giáo dục chung, không phải tư vấn đầu tư, pháp lý hay thuế.

This page is general education, not investment, legal, tax or financial advice, and not a projection or guarantee of any return. Every figure in the worked example is made up and rounded to teach the mechanics; both IRRs, the equity multiples and the sensitivity case were computed from the cash flows shown. Túy “Dewey” Luong, CCIM — Founding Broker, SERHANT. Atlanta · 678-707-2498 · dewey.luong@serhant.com