Understanding IRR, Cash Yield, and Equity Multiple

    These are three commonly used metrics to calculate the real estate investment returns. Find out their differences and determine which to use to evaluate your investments!

    Understanding IRR, Cash Yield, and Equity Multiple

    For real estate investors, syndicators and others involved in the field, investment terminology can appear to be an alphabet soup of mysterious acronyms. There are three in particular that are related to the return on real estate investments, and each has its own unique meaning and purpose. These include Cash Yield (as known as the Cash-on-Cash Return), Internal Rate of Return, and Equity Multiple.  Read on to learn their differences and how they could help you when exploring real estate investments.

    Internal Rate Return

    One of the most common metrics used to gauge investment performance is the Internal Rate of Return (IRR). This is one of the first performance indicators you are likely to encounter when browsing real estate opportunities. The IRR is defined as the discount rate at which the net present value of a set of cash flows (i.e., the initial investment, expressed negatively, and the returns, expressed positively) equals zero.

    In simpler terms, it is the rate at which a real estate investment grows, which also factors in the compounded annual rate of return. One of the keys to IRR analysis, is realising that timing plays an important role. Both the duration of the investment period and the timing that cash distributions are paid to investors would have a substantial influence on this equation.

    Typically expressed as a range of percentages, the IRR is the annualised rate of earnings on an investment. While there is no concrete definition tying property types to a certain level of IRR, the following IRR ranges  are typically associated with real estate investments based on these investment approaches.

    Internal Rate of Return Range

    Read also: What is Compound Annual Growth Rate (CAGR)?

    Cash Yield

    Cash Yield is the simplest way to evaluate the performance of a real estate investment. It utilises a formula to calculate the return on investment by taking the property’s annual net cash flow and dividing it by the investment’s downpayment; this is expressed as a percentage.

    One important detail to keep in mind is that Cash Yield does not include the property’s appreciation or any principal debt payments.

    Appreciation is only taken into consideration when it is realised after the property is sold. It also does not include principal debt payments. Suppose that you bought a property and your net cash flow was $5,000, and the cash invested in your property was $50,000. In that example, your Cash Yield would be 10% ($5,000/$50,000). The down payment would usually be the net property investment,  which is the property’s cost minus the amount you borrowed.

    Equity Multiple

    The equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested. Here is the equity multiple formula:

    Equity Multiple Formula

    For example, if the total equity invested in a project was $1,000,000 and all cash distributions received from the project totalled $2,500,000, then the equity multiple would be $2,500,000 / $1,000,000, or 2.50 times.

    So, what does the extent of an equity multiple indicate? An equity multiple that is less than 1.0 times indicates that you are receiving in return less cash than you invested. An equity multiple greater than 1.0 times, on the other hand, means that you are receiving more cash than the amount that you have invested. In our example above, an equity multiple of 2.50 times simply means that for every $1 invested in the project, an investor is expected to get back $2.50, including the initial $1 investment.

    Read also: What is Loan-To-Cost (LTC) Ratio?
    Read also: What is Debt-to-Equity (D/E) Ratio and What is it Used for?

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    Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.