Buy-to-Let Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is a calculation of the return on the investment over the discount period. It is the discount rate required to make the NPV of net rents and other income match the investment required.

In simple terms, it is the rate of interest that would have to be earned on a savings account to make the same gain over the period as is made by the investment in the project.

In our example the IRR is 2.34%, before tax is taken into consideration. The IRR of net rents after tax falls to 1.86% for a basic rate taxpayer, or 1.35% for someone on the higher 40% tax rate.

Few people would want to invest in this project based on the rental returns, even though the rental income was quite sufficient to satisfy a lender that it adequately covers the interest on the mortgage. Most buy-to-let landlords invest for the capital gains from rising house prices, which we will examine in a moment.