Levered vs Unlevered IRR: What’s the Difference in Real Estate?

A sponsor’s deck shows an 11.5% IRR. The same property, bought without a loan, would earn 7.7%. Both numbers are correct; however they measure different things.

Unlevered IRR is a property’s return as if it were bought entirely with cash. Levered IRR is the return on the investors’ equity after the mortgage. The gap between the two shows how much of the return comes from the loan rather than the property, and that gap can shrink or flip when interest rates rise.

This guide explains unlevered and levered IRR, how to calculate each in Excel and one deal run both ways to show when leverage helps and when it hurts.

This article is for educational purposes only and is not investment, tax or legal advice.

The further apart the two numbers are, the more the projected return depends on the debt.

Unlevered IRR measures the property

Unlevered IRR is the internal rate of return of a property’s cash flows as if it were bought entirely with cash. No loan proceeds, interest or loan payoff enter the calculation. Three kinds of cash flow go in:

• At the start: the full purchase price plus closing costs, as a negative number.
• Each year: net operating income (NOI) less capital expenditures.
• At the sale: net sale proceeds after selling costs.

Because it strips out financing, unlevered IRR shows whether the property and the business plan work on their own. It is the fair way to compare two properties, two markets or two business plans that are financed differently. A value-add deal at 70% loan-to-value and a stabilized deal at 50% can’t be compared on levered IRR alone; their unlevered IRRs can.

The takeaway: if the unlevered IRR is weak, no loan structure makes it a good property.

Levered IRR measures the investors’ equity

Levered IRR is the IRR of the cash that flows to the equity investors after the mortgage is paid. The cash flows change in three places:

• At the start: equity only, meaning the purchase price and costs minus the loan proceeds.
• Each year: cash flow after loan payments.
• At the sale: sale proceeds minus the loan payoff.

This is what investors earn at the deal level, and it is the number most offering decks lead with. One caveat matters for limited partners: deal-level levered IRR is usually calculated before sponsor fees and the promote, so the net IRR to LPs is lower. Real Estate Syndication Structures explains how fees and profit splits work.

The takeaway: a strong levered IRR is only as safe as the loan behind it.

How to calculate both in Excel

IRR is the discount rate that makes the present value of all of a deal’s cash flows equal zero. Solving for it by hand takes trial and error, so sponsors and analysts let a spreadsheet do it:

1. Lay out years 0 through 5 across a row.
2. Unlevered row: enter the negative purchase price in year 0, NOI less capital expenditures in years 1 through 5, and add the net sale proceeds in year 5.
3. Levered row: start from the unlevered row, add the loan proceeds in year 0, subtract the loan payments each year and subtract the loan payoff in year 5.
4. Use =IRR(range) on each row for yearly cash flows, or =XIRR(values, dates) when cash flows land on uneven dates, such as a sale partway through a year.

Building the levered row from the unlevered one means the only difference between the two is the debt. That makes the effect of leverage easy to see and makes errors easier to catch.

One $10 million property, calculated both ways

The example below is kept simple on purpose, so the effect of the loan is easy to follow:

• Purchase price of $10,000,000, with NOI of $600,000 a year (a 6% cap rate), flat for simplicity
• Sold at the end of year 5 for $11,000,000 after costs
• Levered case: a $6,500,000 interest-only loan (65% of the price) at 5.5%, so investors put in $3,500,000
• No capital expenditures, fees or promote

The levered yearly cash flow of $242,500 is the $600,000 of NOI minus $357,500 of interest. In year 5, investors also receive the $11,000,000 sale proceeds minus the $6,500,000 loan payoff.

The results:

• Unlevered IRR: 7.71%, with a 1.40x equity multiple and $4,000,000 of profit on $10,000,000 invested
• Levered IRR: 11.47%, with a 1.63x equity multiple and $2,212,500 of profit on $3,500,000 invested

The levered version earns less profit in dollars but a higher IRR, because investors put in about a third as much money and the loan costs less than the property earns.

Why levered IRR is usually higher, and when it isn’t

Leverage raises IRR when the loan costs less than the property earns. This is called positive leverage. When the loan costs more, leverage lowers the return, which is negative leverage. Running the same property at three loan rates shows the difference.At 5.5%, leverage works. The loan costs less than both the 6% cap rate and the 7.71% total return, so yearly cash yield and IRR both rise.

At 7.5%, it barely helps. The loan costs more than the property’s 6% yearly yield, so cash-on-cash drops to 3.2%. IRR still edges above the unlevered return at 8.08%, because 7.5% is just below the property’s 7.71% total return and the sale gain carries the result.

At 9.5%, leverage hurts. The loan costs more than the property earns in total. Investors fund a $17,500 shortfall each year, and IRR falls to 4.70%, below the all-cash return.

Leverage also magnifies a weak sale. If the property sells for $9,500,000 instead of $11,000,000, the unlevered IRR falls to 5.10%. The levered IRR, even with the cheap 5.5% loan, falls further to 4.31%, because the whole drop in value comes out of a smaller equity base.

The takeaway: leverage doesn’t create returns. It amplifies whatever the property does, in both directions.

Investors need both numbers

Unlevered IRR judges the property and the business plan. Levered IRR judges the deal as investors will experience it. Looking at only one hides half of the picture.

A wide gap between the two means much of the projected return depends on the debt. That can be fine with cheap, fixed-rate, long-term debt. It is riskier with floating-rate debt or a loan that matures before the planned sale, since the refinance or extension may come at a higher rate.

Questions worth asking a sponsor:

• What are the projected unlevered and levered IRRs?
• What is the loan rate, is it fixed or floating and when does the loan mature?
• What is the projected IRR to LPs after fees and the promote?

The takeaway: if a deck shows only the levered IRR, ask for the unlevered one. 

You can see more on IRR in our other blog post. You may also go deeper into levered IRR in this article

Levered IRR vs cash-on-cash return

Cash-on-cash return measures one year’s cash yield on the equity invested. Levered IRR covers the whole hold, including the sale and the timing of every cash flow.

The 7.5% case shows why both matter. Levered IRR still looked acceptable at 8.08%, but yearly cash flow fell to 3.2% of equity. Investors who rely on distributions for income would feel that every quarter, even if the sale eventually makes up the difference. More on both metrics is in the syndication terminology guide.

The bottom line

Unlevered IRR tells sponsors and investors whether the property works. Levered IRR tells them what the debt does to that result. Read together, they show how much of a projected return depends on the loan and how exposed it is to rates and the sale price.

To model levered and unlevered returns in a pro forma, check out Cash Flow Portal’s underwriting software powered by AI.