Internal Rate of Return (IRR)

Internal rate of return is the annual rate that makes the net present value of all an investment's cash flows equal zero: purchase, each year of operations, and the sale. It is the time-adjusted, multi-year measure that cash on cash return is the year-one shortcut for.

Cash on cash looks at one year of cash flow against the cash invested. IRR adds rent growth, expense growth, loan paydown, a refinance if there is one, and the exit price after selling costs. On the default deal, a 6.3% cash on cash return becomes roughly a 13 to 15% IRR over five years with 3% appreciation and modest rent growth.

The cost is that every one of those inputs is a forecast. An IRR is as reliable as its exit assumption. Cash on cash uses only observable numbers, which is why it screens deals and IRR decides between the survivors. If a deal is 6% cash and 14% forecast, you are mostly buying the forecast, and it helps to know that going in.

Further reading: Internal Rate of Return (IRR) on Wikipedia.