ROI vs IRR: What Each One Measures on a Rental

ROI and IRR measure the same rental and give different answers, because they ask different questions. Return on investment asks how much you gained as a share of what you put in. Internal rate of return asks what that gain worked out to per year, counting when each dollar moved. That is the whole difference between ROI and IRR: ROI has no clock in it, and IRR is mostly about the clock.

A 50% ROI reads the same whether you earned it in two years or in twelve. It is not the same thing. IRR fixes that by turning an entire hold into one annual rate.

ROI vs IRR: the short answer

ROI is a ratio. Gain divided by money in, stated as a percent. No dates required.

IRR is a rate. You list every cash flow with the year it happened, then solve for the annual return that makes the series balance. You cannot produce one without deciding how long you hold and what you sell for.

So, side by side:

• ROI tells you how big the gain was next to your cash. IRR tells you how fast you earned it.
• ROI can describe one year or a ten-year hold. If nobody says which, the number means very little.
• IRR is always an annual rate, whatever the hold length.
• ROI needs numbers you can look up. IRR needs a forecast.

How ROI is calculated on a rental

Gain divided by cash invested.

Take the default property on this site: a $500,000 rental renting for $5,200 a month, with $10,000 of rehab, $6,000 of property tax and $2,400 of insurance. At 25% down, the loan is $375,000 at 7.25% and cash invested comes to $150,000 once rehab and closing costs are counted. Net operating income runs $40,210 and first-year cash flow is $9,512.

Two ROIs come out of that, depending on what counts as gain.

Cash only: $9,512 divided by $150,000 is 6.3%. That is cash on cash return, which is a one-year ROI on cash.

Total: add the $3,630 of loan principal paid down in year one and $15,000 of appreciation at 3%. $9,512 plus $3,630 plus $15,000, divided by $150,000, is 18.8%.

The calculator’s simple tab is the same arithmetic in its plainest form: $12,000 of annual cash flow on $150,000 invested is 8%.

Notice what none of those three numbers contains. A holding period. They are snapshots of one year.

How IRR is calculated on the same rental

IRR needs a series instead of a snapshot. For a five-year hold on the same property:

• Year 0: $150,000 out.
• Years 1 through 4: cash flow in, starting near $9,512 and rising as rent rises faster than fixed expenses.
• Year 5: that year’s cash flow plus the sale proceeds, after paying off the remaining loan balance and 6 to 7% in selling costs.

Then you solve for the discount rate that makes the present value of that series equal zero. A spreadsheet finds it by trial and error, and the underlying math is ordinary discounted cash flow.

Three of those inputs are not facts. Rent growth, expense growth and the exit price are all assumptions, and the last one moves the answer the most.

The same $500,000 rental under both

Measure	Result
First-year cash ROI (cash on cash)	6.3%
First-year total ROI	18.8%
Five-year total ROI, cumulative	about 87%
Five-year IRR	roughly 13 to 15%

The five-year figures depend on rent growth, the exit price and selling costs, so treat them as a band rather than a result. The point is the gap between the last two rows. An 87% return sounds like a home run. A 13% return sounds respectable and nothing more. They describe the same deal.

Work it out and the gap closes. Turning 87% over five years into a compounded annual figure gives about 13% a year. IRR lands near that but not exactly on it, because IRR also gives weight to cash flow arriving early instead of all at the sale.

That is the practical test for any ROI you are handed. Ask over how long, then annualize it, and see what is left.

Yield vs IRR

Yield is a one-year rate on money already in the deal. Cash on cash return is a yield. So is cap rate. Neither needs a forecast, and neither knows anything about a sale.

IRR is a lifetime rate. It includes the exit, so it absorbs appreciation, loan paydown and selling costs in one figure.

On a financed rental in a market with normal rent growth, the cash yield is usually the lowest of the set, cumulative ROI the largest, and IRR somewhere in between. If your IRR comes in below your cash yield, the forecast is predicting a weak exit, and that is worth reading closely.

When each number misleads

ROI misleads when the time period is missing. A 30% ROI with no period attached cannot be compared to anything. It also misleads when appreciation does most of the work, since the gain is a projection you cannot spend and the selling costs that would turn it into cash have not been subtracted.

IRR misleads in the other direction. It is only as honest as the exit price behind it, and two people can produce a 9% and a 16% IRR on this same property by disagreeing politely about appreciation. It also rewards speed on its own terms. A short project that returns a small dollar gain can post an IRR above 50%, which tells you nothing about whether the gain was worth the effort.

IRR also assumes money that comes out gets reinvested at the same rate, which is rarely true. Modified internal rate of return exists to handle that.

Where cash on cash return fits

Cash on cash return is the one-year cash ROI, and it is the number to screen with, because every input is observable now. If the property cannot clear your cash yield target on honest rent and expenses, no IRR forecast is going to rescue it. Once a deal clears that bar, IRR is the right tool for choosing between it and a deal with a different hold length or a different exit.

For how all three fit together, including total ROI, see the cash on cash vs ROI guide.

Run it on your own deal

The cash on cash return calculator on the Cash on Cash Return home page gives you the one-year side of this comparison in a few seconds: cash flow, cash invested, the percentage, and an all-cash return beside it. Start there, get the yield you can verify, and only then build the five-year forecast an IRR needs.