Many Australian real estate investors understand Capital Growth, Compound Growth and rental return or rental yield, but unless they have invested in Commercial Real Estate before, or are financial professionals, may not know the term IRR.
Simply stated, the Internal rate of return (IRR) for an investment is the percentage rate earned on each dollar invested for each period it is invested. Ultimately, IRR gives an investor the means to compare alternative investments based on their yield.
The IRR is a widely used investment performance measure in commercial real estate, yet it’s also widely misunderstood.
Ultimately, IRR gives an investor the means to compare alternative investments based on their yield. Mathematically, the IRR can be found by setting the Net Present Value (NPV) equation equal to zero (0) and solving for the rate of return (IRR).
If If the above equation scares you don’t worry, we will walk through a detailed example next that shows you exactly and it will leave you with a solid intuition behind the internal rate of return.
The mathematical (and typical) explanation of IRR as “the discount rate that makes the net present value equal to zero.”
While technically correct, that doesn’t exactly help us all that much in understanding what IRR actually means. Once you break it out into its individual components and step through it period by period, this becomes easy to see.
