Cap rate (capitalization rate) is net operating income divided by purchase price. It tells you the unleveraged return a property generates. A $300,000 property producing $18,000 NOI has a 6% cap rate. It's the most common metric for comparing rental properties because it strips out financing and gives you an apples-to-apples comparison.

What is a good cap rate for rental property?

For residential rentals, 5-8% is generally considered solid. Above 8% is excellent but often comes with higher risk (rougher neighborhoods, older buildings, declining markets). Below 5% is common in expensive metros where investors rely more on appreciation than cash flow.

How is cap rate different from cash-on-cash return?

Cap rate ignores financing — it measures the property's return as if you paid all cash. Cash-on-cash return measures your actual return on the cash you invested, factoring in your mortgage. A property with a 6% cap rate could yield a 12% cash-on-cash return with leverage.

What is the 1% rule in real estate?

The 1% rule says monthly rent should be at least 1% of the purchase price. A $200,000 property should rent for at least $2,000/month. It's a quick screening tool — many successful rentals don't pass the 1% rule, especially in higher-priced markets.

What is the BRRRR strategy?

BRRRR stands for Buy, Rehab, Rent, Refinance, Repeat. You buy a distressed property below market value, renovate it, rent it out, then do a cash-out refinance based on the new appraised value to pull out most or all of your original capital and repeat the process.

Where does CapRateCity get its data?

Our city-level data draws from publicly available sources including U.S. Census Bureau population and income figures, Zillow Home Value Index for median prices, HUD Fair Market Rents, and state/county tax assessor records. Data is updated periodically.

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Internal Rate of Return (IRR) for Real Estate: Complete Guide

The annualized return that includes time value of money — and why pros use it instead of cap rate for hold-period analysis.

By NumbersLab · 8 min read

Cap rate tells you a property's first-year unleveraged yield. Cash-on-cash return tells you the leveraged yield in year one. Neither captures what most investors actually care about: the annualized return over the entire hold period, including appreciation and the lump sum you get when you sell.

That is what Internal Rate of Return (IRR) does. It is the most complete return metric in real estate, and once you understand it, it changes how you compare deals.

What IRR actually measures

IRR is the annualized rate of return that makes the net present value of all cash flows from an investment equal to zero. Translated to plain English: it is the discount rate at which the money going in equals the money coming out, averaged across the entire hold period and accounting for the time value of money.

A cash flow today is worth more than the same cash flow five years from now. IRR honors that. A 12% IRR means your investment grew at 12% per year, compounded — same yardstick you use to evaluate a stock portfolio or a bond.

The big idea: IRR is the only return metric that combines monthly cash flow, appreciation, principal paydown, and the timing of every dollar into one annualized number you can compare across deals.

The IRR formula

IRR is defined implicitly. There is no closed-form formula — you solve for the rate r that satisfies:

0 = Σ [CFₜ / (1 + r)ᵗ] for t = 0 to N

Where CFₜ is the cash flow at time t (negative at t=0 for your initial investment, positive in later years for rent and the eventual sale). Spreadsheets handle this with the =IRR() function. You list the cash flows, hit enter, and Excel iteratively solves for the rate.

IRR vs cap rate vs cash-on-cash

These three metrics answer different questions. Mixing them up is one of the most common analysis mistakes.

Cap rate

NOI divided by purchase price, ignoring financing. Snapshot of year one. Useful for comparing properties to each other and to the market. Read our cap rate calculation guide for the full formula.

Cash-on-cash return

Annual pre-tax cash flow divided by total cash invested. Includes financing. Snapshot of year one only.

Internal rate of return

Annualized return over the full hold, including appreciation and sale proceeds. The complete picture.

A property can have a 5% cap rate, 8% cash-on-cash, and 16% IRR — all at the same time. Each metric is correct; they are answering different questions.

How to calculate IRR with cash flows

Build a year-by-year cash flow table. Year 0 is your initial investment (negative). Years 1 through N are net cash flow from operations. Year N also includes net proceeds from sale.

Example: $300K duplex, 5-year hold
Year 0: −$75,000 (down payment + closing costs)
Year 1: +$6,000 (cash flow after mortgage)
Year 2: +$6,500
Year 3: +$7,100
Year 4: +$7,800
Year 5: +$8,500 cash flow + $145,000 net sale proceeds = +$153,500
IRR (Excel =IRR): 22.4%

That same property had a year-one cap rate of about 6% and a cash-on-cash of 8%. The 22% IRR comes from leverage, principal paydown, and 3% annual appreciation compounding over five years. None of that shows up in cap rate or year-one cash-on-cash.

What is a good IRR for real estate?

Benchmarks vary by leverage and risk profile. Rough guideposts:

Leveraged residential rentals

Target 15% to 20% IRR over a 5-10 year hold. Below 12% and you are taking real estate risk for a stock-like return. Above 25% usually means high leverage, value-add work, or a hot market that will not last.

Unleveraged (all-cash) buys

Target 6% to 10% IRR. You lose the leverage multiplier but also the financing risk. This is what institutional buyers and 1031 exchange parking deals often run.

Value-add and BRRRR projects

Target 20%+ IRR. You are taking renovation and refinance risk and should be paid for it. See our BRRRR strategy guide for the full playbook.

Syndications and commercial

LP investors typically see 13-18% projected IRR over 5-7 years. Anything above 20% projected deserves heavy skepticism on assumptions.

Limitations of IRR

IRR is powerful but not perfect. Three things to know.

1. It assumes reinvestment at the same rate

IRR mathematically assumes every dollar of cash flow gets reinvested at the IRR rate itself. If you cannot find another 22% deal to plow your monthly cash flow into, your real-world return will be lower. Modified IRR (MIRR) fixes this by letting you set a separate reinvestment rate.

2. It can be misleading on short holds

A property held one year that earns a 50% return reports 50% IRR. A 10-year hold at 15% IRR builds far more wealth in dollar terms. Always look at IRR alongside total dollars made (equity multiple).

3. Garbage in, garbage out

IRR depends entirely on the assumed exit price. If your sale-year assumption is wrong, your IRR is wrong. Always run sensitivity analysis on the exit cap rate.

Equity multiple is the partner metric. A 22% IRR over 5 years with a 2.4x equity multiple means you turned $75K into $180K. Always look at both: IRR shows the rate, equity multiple shows the dollars.

Putting it to work

Build an IRR model on every deal you take seriously. Even a rough 5-year projection — operations, appreciation at the local market rate, sale at a reasonable exit cap — beats relying on cap rate alone.

If you finance the deal, also model debt math on the Mortgage Math Lab to lock in your debt service inputs. And remember that IRR is pre-tax — your after-tax IRR depends on depreciation, your bracket, and where you live; TakeHomeTax can help you model the personal income side.

IRR is harder to calculate than cap rate, but it is the closest thing we have to one-number truth in real estate investing.

Start with a cap rate, then build the IRR model →

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