IRR is the Internal Rate of Return. This can often get confused with the return on investment and cash on cash because over the period of one year, all these percentages are the same.
IRR specifically takes the time value of money and calculates what the average return is over a period of time and annualizes it. Say you put that 10k in and made 7% per year for 5 years and compounded it each year that equate to a 7% IRR for those 5 years precluded that your 10k was returned to you at the end of the period.
When looking at real estate we know that very seldomly does an asset perfectly return an exact percentage and typically the asset grows in value over the time period. This calculation can take that expected growth and growth in cash flows combined into one metric to look at the investment.
Personally, I don’t really look at IRR because it is a highly manipulated metric. Showing an unrealistic refinance in year 2 instead of year 3-4 will likely turn a 13% IRR deal to 16-17%. Magic! The best way to explaining this is for you to download an IRR calculator spreadsheet or build your own simple one and play around with one.
For what its worth most deals I deem meeting minimal IRR standards is 13-15% but you have to dig a little deeper to uncover the real placements of cashflows and capitalization events… and then dig even deeper to verify the assumptions such as occupancy, rent increases per year, and what reversion cap rate was used.
Again I don’t look for IRR cause its manipulated a lot instead I look at total return on a 5 year basis. Its like sampling a NFL players 40 yard dash but for apartment underwriting. I’m sure there are other ways to do it but weather its right or wrong… I try to be consistent and I’m just trying to go in and pick the best in the field.