What does the internal rate of return (IRR) indicate?

The internal rate of return (IRR) primarily indicates the effective annual earnings rate on an investment. It represents the discount rate at which the net present value (NPV) of all cash flows (both incoming and outgoing) from the investment equals zero. In simpler terms, the IRR is the expected annualized rate of growth an investment is anticipated to generate over its holding period.

Investors use IRR to evaluate the profitability of a project and to compare the potential returns of different investments, allowing them to make informed decisions based on the expected rate of return. A higher IRR suggests a more attractive investment in terms of earning potential, making it a crucial metric in finance and investment analysis.

Understanding IRR helps investors assess whether the investment meets their required return thresholds or benchmarks. It is particularly useful in real estate development and reuse, where cash flow timing and amounts can vary significantly over the life of the project.