# Differences Between IRR & Cap Rate

Capitalization rates and internal rates of return are both tools that can be used to measure the return of an investment. A capitalization rate expresses the income from an investment relative to its price, usually by looking at a single period of income. Internal rates of return, usually abbreviated as IRRs, take a more holistic view of an investment. They're more complicated to calculate but can be more telling.

## Cap Rates

To calculate a capitalization rate, you divide the price of an investment into its income. For instance, if you were going to buy an investment for \$100,000 and you think you can earn \$8,000 a year in profit after subtracting your expenses from your gross income, you would divide \$100,000 into \$8,000 to come up with 0.08, or 8 percent. Cap rates traditionally exclude the impact of debt and usually don't look at how much money you plan to gain or lose when you sell the investment.

## Static vs Dynamic

The two types of analyses are very different. A cap rate looks at a return relative to a single moment, while an IRR looks at your return over an entire investment. It's almost like the difference between a photograph and a movie. Both contain information, but the IRR sums up more information over time.

## Making Metrics Meaningful

Both metrics have a basic shortcoming: They're only as good as the information you put into them. A cap rate will tell you what the returns were for a given period or, if you project earnings, can tell you what they'll be for a period in the future. IRRs are almost always based on future projections. In either case, if your projected data are bad, your return estimates will be wrong. When looking at historical data, if you select a period that isn't representative of an investment's true performance, you'll also get a misleading result. With this in mind, using either metric is a mixture of art and science.