# What Is IRR (Internal Rate of Return) for Short-Term Rental Investments?

> IRR measures the true annualized return of an STR investment including appreciation and resale. Learn how to calculate it and when to use it vs. cash-on-cash return.

Canonical: https://www.underwriteapp.com/learn/internal-rate-of-return


## Definition

**Internal rate of return** (IRR) is the annualized return rate that makes the net present value of all cash flows — both in and out — equal to zero over a defined hold period.

In plain English: IRR is the single annual return percentage that accounts for every dollar you put in, every dollar of cash flow you receive, and the lump-sum proceeds when you sell.

It answers: **what is my total annualized return if I buy this property, operate it for X years, and sell it?**

## Why IRR Is More Complete Than Cash-on-Cash

[cash-on-cash-return](/learn/cash-on-cash-return) only measures annual operating cash flow against your initial investment. It ignores:

- **Equity paydown** — your mortgage balance shrinks every year
- **Appreciation** — the property grows in value over time
- **The time value of money** — cash received in year 1 is worth more than cash received in year 5

IRR captures all of these by weighting cash flows by *when* they occur. A deal that pays you $5,000/year for five years and then returns $600,000 at sale has a very different IRR than a deal that pays $20,000/year but sells for only $300,000.

## The IRR Formula

IRR is the rate $r$ that satisfies:

$$0 = \sum_{t=0}^{n} \frac{CF_t}{(1+r)^t}$$

Where:
- $CF_t$ = cash flow in period $t$ (negative at $t=0$ for your initial investment)
- $r$ = the IRR you're solving for
- $n$ = number of periods (years)

You don't calculate IRR by hand — use Excel/Sheets `=IRR()`, a financial calculator, or the Underwrite analyzer. What matters is understanding what goes into it.

## Worked Example

**Property:** 3-bedroom cabin, Blue Ridge, GA  
**Purchase price:** $450,000  
**Down payment (25%):** $112,500  
**Loan:** $337,500 at 7.0%, 30-year fixed  
**Closing costs + furnishing:** $30,000  
**Total cash invested (Year 0):** $142,500

**Operating assumptions:**
- Gross revenue: $72,000/year
- Operating expenses: $32,000/year
- NOI: $40,000/year
- Annual debt service (P&I): $26,950/year
- Annual cash flow: **$13,050/year**

For simplicity, assume cash flow is flat across the hold period (no growth).

**Exit assumptions:**
- Hold period: 5 years
- Annual appreciation: 3%
- Exit value: $450,000 × (1.03)⁵ = **$521,700**
- Remaining loan balance at year 5: ~$314,000
- Net sale proceeds: $521,700 − $314,000 − $15,000 selling costs = **$192,700**

**Cash flow timeline:**

| Year | Cash Flow |
|------|-----------|
| 0 | −$142,500 (initial investment) |
| 1 | +$13,050 |
| 2 | +$13,050 |
| 3 | +$13,050 |
| 4 | +$13,050 |
| 5 | +$13,050 + $192,700 = +$205,750 |

Plugging these into `=IRR()`: **IRR ≈ 16.8%**

Your cash-on-cash return on this deal is $13,050 ÷ $142,500 = **9.2%** — a reasonable annual metric. But IRR tells a fuller story: including equity paydown and 3% appreciation, your actual annualized return is closer to **17%**.

## IRR vs. Cash-on-Cash Return — When to Use Each

| | Cash-on-Cash | IRR |
|---|---|---|
| **Measures** | Annual cash yield on invested capital | Total annualized return over hold period |
| **Includes appreciation** | No | Yes |
| **Includes equity paydown** | No | Yes |
| **Time value of money** | No | Yes |
| **Best for** | Quick deal screening; comparing annual income | Final hold/sell decisions; comparing multi-year investments |
| **Limitation** | Ignores the full picture | Requires assumptions about exit price and hold period |

**Use CoC when:** You want a fast read on whether a property generates meaningful annual income relative to what you're putting in.

**Use IRR when:** You're modeling a specific hold period and want to compare this investment against alternatives (stocks, other real estate, etc.) on an apples-to-apples annualized basis.

## What Is a Good IRR for STR?

| IRR | Assessment |
|-----|------------|
| < 8% | Thin. Likely better alternatives with less operational burden. |
| 8–12% | Acceptable. Meets most investors' hurdle rate, but limited buffer. |
| 12–15% | Good. Solid risk-adjusted return for active STR management. |
| 15–20% | Strong. Typically requires above-market revenue or below-market acquisition. |
| 20%+ | Excellent. Rare at scale — validate your assumptions carefully. |

These ranges assume a 5-year hold. Shorter holds skew IRR up (appreciation concentrated in fewer periods) or down (closing costs amortized over fewer years).

## Limitations of IRR for STR Analysis

**IRR is only as good as your exit assumptions.** The sale price at year 5 or 10 dominates the calculation. A 1% difference in assumed appreciation can swing IRR by 2–3 percentage points. Always run IRR at conservative (0–2%) and base case (3%) appreciation scenarios.

**IRR doesn't tell you absolute dollars.** Two deals can have the same IRR, but one returns $50,000 more in total cash. Pair IRR with **equity multiple** (total dollars returned ÷ dollars invested) to get the full picture.

**IRR assumes reinvestment at the IRR rate.** The math assumes interim cash flows are reinvested at the same IRR, which is rarely achievable. For very high IRRs (25%+), consider modified IRR (MIRR) for a more conservative estimate.

**Short hold periods amplify closing cost drag.** If you sell in 2 years, the ~5% in closing and selling costs (buy + sell) hits IRR hard. A property with a 15% IRR at a 5-year hold might be a 7% IRR at a 2-year hold.