Two pre-leased properties can show the same 6.75% yield and still give you very different returns. The yield only tells you this year's rent against the price. It says nothing about rent increases, buying costs or the price you sell at.
The short answer
Rental yield is one year's rent divided by the price. It is a snapshot. IRR (internal rate of return) is the yearly return across your whole holding period. It counts what you pay in, the rent you collect each year and the money you get back when you sell.
Use yield to compare offers quickly. Use IRR to judge the full investment. In the example below, the biggest swing comes from the exit price, and the exit price depends on how much lease is left when you sell.
Why it matters
Fact: Microsoft's Excel help describes the internal rate of return as "the interest rate received for an investment consisting of payments" and income, and notes that the rate calculated by IRR is "the interest rate corresponding to a 0 (zero) net present value".
In plain words: IRR is the single yearly rate that makes all the money going out and all the money coming in balance out, after allowing for timing.
Yield misses three things that IRR picks up:
- Buying costs. Stamp duty, registration and other costs raise what you really put in. Yield is usually quoted on the price alone.
- Rent growth. An escalation clause lifts the rent over time. Yield shows only today's rent.
- The exit. What you sell for can add to your return or take a large part of it away.
How to work out IRR, step by step
- Year 0: write the price plus all buying costs as one negative number.
- Each year: write the rent you will actually receive, using the escalation dates in the lease.
- Exit year: add the sale price, after selling costs, to that year's rent.
- Calculate: in Excel or Google Sheets, use =IRR() on the yearly column. Microsoft's help notes that the values "must contain at least one positive value and one negative value".
- For real dates: if cash flows do not fall on even yearly dates, use =XIRR(values, dates). Microsoft describes XIRR as returning the internal rate of return "for a schedule of cash flows that is not necessarily periodic".
Want help building the cash flow for a property you are looking at? Share the lease terms with our team.
Illustrative example
Illustrative example. Not a real property or tenant. All figures are made up to show the method.
A shop is offered at ₹8 crore with rent of ₹4,50,000 a month (₹54 lakh a year). That is a 6.75% gross yield. The lease is 9 years, with 15% escalation every 3 years. Assume buying costs of ₹50 lakh, so the total money in is ₹8.5 crore. Assume you sell at the end of year 6, when 3 years are left on the lease.
Simple assumptions, to keep the method clear: rent counted once a year, no vacancy, no tax, no selling costs, and the security deposit left out.
| Years | Rent / month | Rent / year |
|---|---|---|
| 1 to 3 | ₹4,50,000 | ₹54.0 lakh |
| 4 to 6 | ₹5,17,500 | ₹62.1 lakh |
| 7 (the buyer's first year) | ₹5,95,125 | ₹71.4 lakh |
You collect ₹3.48 crore of rent over six years. Now the exit. A buyer prices the shop on the year-7 rent of ₹71.4 lakh. What yield will that buyer want?
| Scenario | Buyer's yield | Sale price | Your IRR |
|---|---|---|---|
| A. Buyer accepts the same yield | 6.75% | ₹10.58 crore | about 9.9% |
| B. Buyer wants a little more | 7.5% | ₹9.52 crore | about 8.4% |
| C. Buyer wants more again | 8% | ₹8.93 crore | about 7.5% |
| D. No escalation, sold at ₹8 crore | – | ₹8.00 crore | about 5.5% |
Same property, same 6.75% headline yield. The return ranges from about 5.5% to about 9.9% a year, depending on the escalation and the exit.
Two things stand out. First, the gross yield on the full ₹8.5 crore put in is only 6.35%, not 6.75%. Second, in scenarios A to C the escalation helps, but the buyer's yield at exit moves the result by more than two percentage points.
The VRX lens: yield is not the thesis
Opinion: a yield is one number. The real picture is tenant, lease, cash flow, asset, location, price and exit. IRR is useful because it forces you to put a number on the exit, which most yield quotes ignore.
Opinion: a buyer looking at a lease with only 3 years left may ask for a higher yield than you did when 9 years were left. That is why residual lease term belongs in your exit plan from day one.
At VRX Capital, we work out the yield ourselves from the stated rent and the price, instead of repeating a quoted percentage. The same habit applies to IRR: build it from the lease, not from a brochure.
Common mistakes
- Comparing properties on headline yield alone.
- Leaving buying costs out of the money put in.
- Assuming you will sell at the same yield you bought at.
- Adding escalation that is not written in the lease. See how to compare escalation clauses.
- Counting rent from day one when the lease has a rent-free period.
- Treating IRR as a promise. It is only as good as the assumptions you feed it.
Checklist before you commit
- Price plus all buying costs, as one total
- Rent for each year, using the escalation dates in the lease
- Rent start date and any rent-free months
- Years left on the lease and lock-in at your planned exit
- Three exit prices: same yield, higher yield, and no growth
- IRR worked out for each exit, before and after tax
Tax on rent and on the sale changes your real return. Our guide on net after-tax yield covers the basics. Please verify how tax applies to your own case with a qualified chartered accountant.
FAQ
What is the difference between rental yield and IRR?
Rental yield is one year's rent divided by the price. IRR is the yearly return over the whole holding period, counting the purchase, every year's rent and the sale.
Why is my IRR different from the yield?
Because IRR includes buying costs, rent increases and the sale price. Costs push it down. Escalation and a good exit push it up.
How do I calculate IRR in Excel?
Put the total money in as a negative number in year 0, then each year's rent, with the sale price added in the last year. Use =IRR() on that column, or =XIRR() if you have exact dates.
Does a higher IRR mean a better property?
Not on its own. A high IRR can come from an optimistic exit price. Check the tenant, the lease and the exit assumption behind it.
Should I include the security deposit?
For a fuller picture, yes. If the deposit passes to you at purchase, refunding it to the tenant later becomes your cost, so it changes your cash flow. See our guide on the security deposit.
Talk to VRX Capital
Looking at a pre-leased property and want to see the full return, not just the yield? Send us the price and lease terms, and we will help you map the cash flow and test the exit. You can also visit our investor page.
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