Internal rate of return (IRR) and return on investment (ROI) are similar yet different, but both necessary when determining rental property value. In this article, we’ll explain what both ROI and IRR look like and how, as an investor, you can use both to assist in improving your portfolio. Let’s get started with the definitions, then look at how to use IRR and ROI when determining rental property value.
Defining IRR
IRR (internal rate of return) is used to calculate the rate of return on an investment, using a specific formula and time period. In other words, that means that by using IRR, an investor gains an idea of the percentage they’ll make on each dollar they spend over a specific period of time. It’s used to predict how an investor’s dollar should grow when investing in a property. In general, you want a high IRR.
Defining ROI
ROI (return on investment) is calculated by subtracting the investment cost from the profit of a property investment. It’s often used when a property investor wants to know the current cash flow value. ROI shows us how much the investment earned.
The greatest difference between ROI and IRR is that IRR is used when predicting the future of an investment (the time period may be the next year, several years, or more), and ROI is used to determine the present time, or current cash flow value.
When To Use IRR
Use IRR when trying to decide if an investment property is worth hanging onto or purchasing to begin with. Determining IRR is a bit of a guessing game because it’s predicting the future, but still, it’s the best way to get an idea of how the investment might work out over the lifetime of owning it.
When To Use ROI
Use ROI for a quick temperature check on your current rental property. If you want to see what your current cash flow is for the month or year on your rental property, subtract any cost from the profit, and you’ll easily see your rate of return.
As you can see, using IRR and ROI when determining rental property value is important—IRR and ROI each have their place but work differently. If you’re still unsure or have more questions about IRR vs. ROI, contact Excalibur Homes, and we’ll get your questions answered. We were voted “Best in Georgia,” thanks to our many years of trusted service as one of the best real estate investment companies in Atlanta. Whether seeking advice, an investment property, or full-service property management, Excalibur Homes has you covered.
