What Does IRR Mean?

What Does IRR Mean?

Real estate and investment calculations can look terrifying if you’re not a professional investor, stockbroker or accountant — and sometimes, they can be off-putting even if you are.

We’re here to help clear up one mathematical aspect of real estate investments that can be a powerful tool in helping you decide where to invest your money — a potential investment’s internal rate of return, a figure you’ll typically see abbreviated as its IRR.

A project’s internal rate of return is a projected rate of growth it is expected to return within a set amount of time, which you — the potential investor — work into a formula (don’t panic — we’ll explain it.)

A project’s IRR can be a fairly solid way of predicting whether it will be a good investment. However, we’ll caution you against looking at mathematical projection as a crystal ball — an IRR is very rarely perfectly precise.

Since it’s calculated using the same formula used to calculate an investment’s net present value, an IRR can easily be compared against a different project’s current value, or against specific existing securities, giving investors more information about how a potential investment will stack up against current “known commodities.”

How it’s calculated

OK, this part contains a little math. Bear with us.

  • The formula to calculate an IRR is the exact same one used to calculate a net present value — an NPV.
  • That formula uses initial investment, net cash inflow and interest rates to calculate the amount of money an investment needs to make to give you a certain amount.
  • You can look at it as the percentage rate earned on each dollar invested for each period it is invested — the percentage of each dollar you make, for each year you invest it, for example.
  • In real estate holdings, that means the percentage on each dollar of your original investment, for every year until you sell the property, or your share.
  • You can see how that would be a handy figure to have in your back pocket as you navigate potential investments.

IRR is not a crystal ball

  • We want to reiterate: a project’s internal rate of return is no guarantee of how it will perform in the “real world.”
  • It’s not a guarantee of annual compound rate of return on an initial investment.
  • An IRR figure is also not calculated with the inherent assumption that interim cash flows are reinvested in the project, which isn’t always the case — that can change the end result.
  • We are happy to help you decide which fund is best for you. Reach out to RE/DEV and let us give you a hand.
By |2018-10-03T05:16:24+00:00August 10th, 2018|Real Estate Investing|0 Comments

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