What is a Target IRR in Real Estate?

In real estate, a Target IRR (Internal Rate of Return) is the return that investors or sponsors aim to achieve on a project or investment over its holding period. It is a forward-looking benchmark that helps guide decisions about acquisitions, developments, or value-add strategies.

Key Points

• Definition: The IRR is the discount rate that makes the net present value (NPV) of all projected cash flows (income, expenses, sale proceeds) equal to zero. The target IRR is the projected rate sponsors promise or strive to deliver.
• Use: Investors often set a target IRR (e.g., 12–18% for many opportunistic real estate deals) to determine whether the risk/return profile of a project is attractive.
• Cash Flow Driven: It considers both interim cash flows (rents, distributions) and terminal value (sale or refinance).
• Risk Benchmark: Higher-risk projects (like ground-up developments) usually have higher target IRRs, while core stabilized assets tend to have lower targets because they are safer.
• Alignment Tool: Used in structuring waterfalls (profit-sharing agreements) so that sponsors receive performance fees (carried interest or promotes) only if they meet or exceed the target IRR thresholds.

Example

• A multifamily developer projects construction and lease-up will take 3 years, with a sale in year 5. They might set a target IRR of 16%. If actual cash flows—rents collected and sale proceeds—discounted back to the initial investment meet or exceed that 16% return, the project is considered a success relative to the goal.