What is an IRR?
IRR is described as the initial rate of return. Investors use this to know how an investment opportunity adds up against their investing criteria. But how do you know what IRR to achieve on a particular investment? Every deal is different, as well as it depends on the asset class you are investing in. There are a ton of investors out there who shoots for 14% to 15% IRR on their assets, but they have no clue where or how they came up with this number, and if asked they would not be able to explain it to their investors.
What does this mean for the investor? Here is the short version: "A property's internal rate of return is an estimate of the value it generates during the time frame in which you own it. Effectively, the IRR is the percentage of interest you earn on each dollar you have invested in a property over the entire holding period." Source: (https://smartasset.com/investing/internal-rate-of-return-real-estate-investments)
Each asset class will have a different IRR target, and it's important to know what's your target IRR and how did you come up with this number. Its impossible to understand IRR without understanding net present value (NPV). NPV is more accurate then the IRR because it calculates the return of the investment in much more detail then the IRR. Also NPV can let you know if you are overpaying for a property, even if the IRR says its a good investment. More on NPV later.
When using IRR make sure you understand the ins and outs of how the IRR is calculated and exactly what it means for its asset class, the investment opportunity, and the investors.
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