When sizing up an investment opportunity, it’s vitally important to know the specifics of what you’re getting involved in. This comes down to understanding several financial figures that are associated with the investment proposition: chiefly, the internal rate of return (IRR) and cash yield. These two figures provide investors with a sense of the expected performance of an investment, as well as how well the same investment has performed to-date.
Just because IRR and cash yield are important success metrics for investors doesn’t mean they’re inherently easy for newcomers to understand. Understanding these figures, and the role they play in investing, is a crucial part of anyone’s due diligence processes before pulling out their checkbook.
If you’re new to investing, or just want to hone your financial knowledge, having a breakdown of IRR and cash yield to maturity is a great way to further your understanding of certain kinds of investments, such as bonds and farmland investing.
IRR measures the expected future rate of return on an investment—basically, the profit one can expect to make on the money they’ve invested. It is one of the first financial performance indicators you are likely to encounter when browsing real estate crowdfunding opportunities.
Unlike a regular rate of return, an IRR is a forecast of future performance and not a guarantee. That’s because IRR calculates the investment’s potential, rather than its actual performance. This figure also doesn’t account for outside factors that could influence an investment’s potential returns, such as inflation, financial risks (potential losses), the cost of capital (what a project would cost if executed), and other factors. IRR is determined by the company offering the investment opportunity in question; they derive this figure based on due diligence and vetting of the investment product they’re offering.
Say, for example, that an investment group has an opportunity to purchase a farm for $3 million. The group has determined that the farm will earn $75 thousand per year from crop sales for the next 5 years. Excluding other factors, such as the lifespan of farm equipment and land appreciation, the IRR for this opportunity is just under 8 percent (7.931 percent, to be exact).
IRR allows you to size up an investment opportunity without knowing each and every specific detail about the proposition. This metric provides a thumbnail of the rate of return that the issuer expects to see from the investment under ideal conditions, which can help you determine if the return on your investment is worth the money you’d put into it.
At FarmTogether, we offer the IRR of each farmland investment opportunity to help our partners find the right investment opportunity for their needs. Returns range from 7 to 13 percent on average, and you can size up each investment option at-a-glance to help you evaluate the IRR of each of our open offerings.
Cash yield (or cash-on-cash yield) is a calculation that estimates the annual net payout throughout the duration of an investment, divided by the initial amount invested. This figure is another option to help estimate an investor’s return on an investment. Cash yield is different from IRR because cash yields pay out in greater amounts in the latter years of an investment term.
For instance, a one-year investment period would have the same IRR and cash yield. A multi-year investment, however, would have a different cash yield that may factor in higher payouts as time goes on. Let’s say an investor bought farmland priced at $3.5 million dollars, and the farm generates $200,000 in annual revenue. The annualized cash yield would be 5.7 percent, as you would divide the annual revenue by the total price of the investment.
This figure can help investors better understand the cash distributions they might expect from their investment. This is central to investors who want a forecast of the returns they might receive from the money they put into an investment. Granted, the actual yield may vary depending on a host of factors. With farmland investing, this may include a poor harvest season or lower commodity prices than expected when the cash yield percentage was tallied.
Both IRR and cash yield are helpful metrics that add context to an investing opportunity. IRR calculations made by investment professionals offer a glimpse into the potential upside of an investment, and cash yield helps forecast the kind of annual returns one might expect based on the nature of the investment up for offer.
Having these metrics on-hand when making a financial investment decision is crucial: they provide you with more context before you take the plunge, and provide you with a way to forecast your gains based on real-life financial figures.
Ultimately, however, these numbers are only as good as the group behind their calculations. FarmTogether is the leader in farmland investing because its team of experts know how to identify the right investments as well as conduct due diligence that creates reliable forecasts. Plus, they work with each of their prospective and active investors to help them navigate the process of identifying and selecting the right farmland investment opportunity for their portfolio. Getting started with FarmTogether only takes $10,000, which opens you up to a host of opportunities across the United States.
With a comprehensive understanding of IRR and cash yield, you’ll equip yourself with the ability to spot opportunities and understand their potential upside at a glance. Knowing what the rate of return is for your investment if held until maturity can help you better understand your portfolio and anticipate projected earnings at a glance.
By understanding IRR versus cash yield, you’ll also be well positioned to spot new investments that have a strong potential to deliver major returns—chief among them being farmland investing through FarmTogether. Our investment opportunities have IRRs between 7 and 11 percent on average, meaning you have a broad assortment of options to suit your risk tolerance.
Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.