Internal Rate of Return (IRR) is the rate of return, expressed as a percentage, that each dollar invested in particular property earns during the time period it is invested.  (The mathematical express is a calculus equation which, if viewed here, would not lend itself to an understanding of IRR.)  IRR is calculated using financial software on computer or calculator. 

Of the investment valuation methods discussed on this website, IRR provides the most accurate measure of the investor's true rate of return for a specific property.  IRR not only considers all the factors which affect rate of return that Cap Rate and Cash on Cash account for, but it also allows for after tax effects of an investment, and provides a multi-year forecast of projected income over the anticipated holding period, calculating return on the investment at the end of the holding period.

The downside of IRR is that it does not account for how the investor's dollars are handled as they come out of the investment.  IRR is specific only to the property and the time the dollars are invested in it.  Because various investment opportunities almost always have different cash flows, time periods, and initial investment amounts, IRR for one property cannot be compared directly to IRR for another, since the issue of how dollars are reinvested once they leave the investment is not addressed.  (See Capital Accumulation for a discussion of this issue.)

Other's definitions of of IRR include the following:

"The rate of discount that equates the present value of the investment's cash outflows with the present value of the investment's cash inflows.  Internal rate of return is analogous to maturity for a bond."

                                                                          David L. Scott, 1997, Wall Street Words, page 197

"That discount rate that reduces the future cash flows to just equal the amount of money invested."

                Dennis J. McKenzie & Richard M. Betts,1996 Essentials of Real Estate Economics, page 396

 "The annualized yield rate or rate of return on capital that is generated, or capable of being generated, within an investment or portfolio over a period of ownership.  The IRR is the rate of discount that makes the net present value of the investment equal to zero.  The IRR discounts all returns from the investment, including returns from its termination, to equal the original capital outlay."

                                 The Dictionary of Real Estate Appraisal, 1998 The Appraisal Institute, page 188

"The percentage rate earned on each dollar that remains in an investment each year.  The IRR of an investment is the discount rate at which the sum of the present value of future cash flows equals the initial capital investment."

                       CI 101: Financial Analysis for Commercial Investment Real Estate, CCIM Institute, 2002, Course Glossary, page 10.4