Internal rate of returnIRR

The internal rate of return is the single discount rate at which an investment's cash outflows and inflows, laid out on a timeline, exactly cancel. It accounts for how much money goes in, how much comes back, and when. Two projects that return the same total dollars will have different IRRs if one returns them sooner.

In development, the equity IRR is the number investors typically underwrite to. It includes the years of contributions during entitlement and construction, the cash flow once the building is leased, and the proceeds of an eventual sale or refinancing, valued at an assumed exit cap rate. Because it is so sensitive to timing, delays that push income further into the future reduce the IRR even if every dollar eventually arrives.

IRR has known limits. It assumes interim cash can be reinvested at the same rate, it can mislead when comparing projects of very different sizes, and it can be inflated by leverage or by short holding periods. Investors usually look at it alongside the cash-on-cash return and a plain multiple of the money invested.

For rent, the target IRR is the equity investor's price. A developer designs a building and sets its pro forma rent so that the projected cash flows clear that target. When the target rises, whether because interest rates make safer investments more attractive or because construction is seen as riskier, the rent required for a new project to proceed rises with it.