Why IRR is Not the Rate of Return for Your Investment: Introducing AIRR to the Real Estate Community

Abstract

The internal rate of return (IRR) is used extensively in the real estate sector. Unfortunately, the IRR calculation itself assumes interim investment values that are mechanically generated by the IRR equation itself and will almost surely differ from the true interim values of the project under consideration. To the extent that these values differ, the IRR result will not be an accurate rate of return. Furthermore, from an ex post, i.e., performance reporting standpoint, such values implied by the IRR will almost certainly contradict any estimated project values being used for time-weighted rate of return (TWR) purposes. A new metric called Average IRR (AIRR) produces a correct money-weighted rate of return (MWR) for a project. Furthermore, AIRR has none of the other problems that the IRR has (e.g., it always exists and is unique), and it appropriately accounts for the amounts actually invested over the course of the investment.