Internal Rate of Return: Calculating Annual Expected Return
In this Drinks and Deep Dives show, Chelsea Scott joined Chris in the studio to talk about Internal Rate of Return (IRR). This is a powerful but complex metric for calculating annual expected returns. It’s a dynamic way to measure returns because it considers the time value of money (a dollar tomorrow is worth less than a dollar today) and takes into account all cashflow: initial negative cash outlay (down payment), annual cashflows, and proceeds from the sale. Listen to the podcast to find out how to use this calculation to help you decide whether to buy a property in a cashflow or appreciation market.

We can even use this metric to determine how much of a return is generated from cashflow vs appreciation.  Using this information, we can decide whether it’s better to buy a property in a cashflow or appreciation market, depending on an investor’s needs and goals.  IRR is too complicated to calculate by hand and requires a spreadsheet or software to complete.  While it’s one of our favorite metrics, we don’t often discuss it due to its complexity.  We’re going to cover it more in future episodes, so stay tuned!

Three Learning Options!
  1. Listen to the podcast “#288: DDD: Internal Rate of Return: Calculating Annual Expected Return” on the Denver Real Estate Investing Podcast
  2. Watch the YouTube video (at the bottom).
  3. Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.

cash flow vs appreciation

The IRR, or the internal rate of return is a useful measure when evaluating the performance of an investment with multiple payouts over a period of time.  When using the IRR to evaluate a real estate investment, the calculation will account for varied cash flows, capital improvement expenses, refinancing and the sale of the property over time, factoring in the time-value of the investment.

In this podcast we take a look at holding a condominium purchased for $200,000 with $50,000 down.  In one scenario we start with the amount of money borrowed, which is $150,000 and the rate of return on money that the investor borrowed.  In this case, the IRR ended up at over 10%, using a 3% appreciation rate year-over-year and a 4% interest rate on the loan.  So, that means you are making money on borrowed funds.

Internal rate of return for Denver condo

In the second scenario, we do the same for the downpayment of $50,000.  When looking at the money you contributed to the investment, this IRR is 24.71%.  An incredible return!

internal rate of return spreadsheet for Denver condo

After evaluating the IRR of this investment, we then partitioned out the IRR using the above cash flows, the initial investment of $50,000, a 3% annual appreciation rate and a 4% interest rate to determine that the amount of cash flow and appreciation being returned to the investor over a 10 year period, is almost 54.5%/45.5%, respectively.  Since this is an actual condo purchased here in Denver, it shows that this particular investment property is located in a market with almost as much cash flow coming back to the investor as appreciation of the property.

IRR partition by year Denver rental property

YouTube Video: Internal Rate of Return: Calculating Annual Expected Returns

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Rental Property Spreadsheet • House Hacking Spreadsheet BRRRR Calculator Spreadsheet • Fix and Flip Deal Analyzer Investing Maps • Rehab Pricing Estimator
Authors
Chris Lopez
Chris Lopez is a Denver area real estate entrepreneur and investor, as well as the host of Bigger Pockets’ House Hackerz and the Denver Real Estate Investing Podcast.
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