When it comes to investing in real estate, there’s a lot you can (and should) know about the properties you own or are considering for purchase. But how much do you know about the market as a whole? Understanding—and keeping tabs on—the sector and your region’s activity is crucial to knowing when to buy, when to sell, and what types of property will deliver the highest ROI.
Cash flow
Cash flow is the amount of money that comes into a property. It’s a measure of the health of a property investment. A healthy property generates positive cash flow—it generates more money than it costs to book, maintain, and operate.
Cash flow can be calculated by subtracting expenses from income. The resulting number represents what is known as “net operating income” (NOI). The difference between NOI and gross rents is called “cash available for debt service” (CAFD).
To calculate NOI:
- Total rent collected less vacancy rate multiplied by unoccupied units = Gross Revenue
- Add back in any non-rental income and subtract miscellaneous expenses like taxes, insurance, utilities etc… – Total Expenses = Net Operating Income
Cap rate
- What is cap rate?
- What does cap rate tell you?
- How do you calculate cap rate?
Cash-on-cash return
Cash-on-cash return is a metric that measures your annual cash flow divided by your initial investment. The results of this calculation are expressed as a percentage, so you can easily compare different investments and properties. For example, if you bought a property for $100,000, and the annual cash flow from the property is $10,000—your cash-on-cash return would be 10%.
Gross rents
Gross rents are the total amount of rent collected from all tenants. Gross rents are the total rent collected from all tenants before expenses are deducted.
Gross rent multiplier
The gross rent multiplier is a ratio that compares the net operating income of a property to its annual rent. It can be used to determine the value of a property and serves as an effective indicator for whether or not you should buy a particular property.
To calculate your gross rent multiplier, take the following steps:
- Add up all of your property’s monthly expenses (mortgage payments, taxes, insurance)
- Subtract this amount from your current monthly income
Net operating income (NOI)
Net operating income (NOI) is the amount of money left over after all operating expenses are paid. It is important to know your NOI because it can be used to compare properties with different rents and it’s a good indication of how much cash flow a property will generate.
One way to calculate NOI is by adding all of your annual income from the property, then subtracting all of your annual expenses. The result will be your net operating income, which you can divide by 12 to get an average monthly figure.
For example:
- Your property generates $1,200 in rent each month.
- You pay $150 per month for insurance on the building and another $100 per month for maintenance costs such as cleaning services or landscaping work that needs doing at some point during each year (a total cost of $250). Now add these together ($350). Then subtract this number from your monthly rent ($1200 + $350 -$1000 = $150). This gives us our net operating income figure—$150 per month!
Internal rate of return (IRR)
IRR is a metric that allows investors to make apples-to-apples comparisons. IRR takes into account how long it took you to get your investment back, including any money you reinvested along the way. IRR is calculated using the following formula:
Debt coverage ratio (DCR)
Debt coverage ratio (DCR) is a financial analysis tool that calculates the relationship between a project’s net operating income (NOI) and its debt, using the formula:
- DCR = NOI / Interest Expense
For example, if you have $100K worth of leases on a property with a debt load of $250K, your DCR would be 0.40 ($100K/$250K). This means you could cover 40% of the total debt with your NOI.
If you had more than one property in your portfolio, this metric can help determine which properties need more attention or should be sold so that they don’t negatively impact your overall portfolio balance sheet. The higher the DCR score, the better off financially you are as an investor; however, keep in mind that just because one property has a higher DCR doesn’t mean it’s necessarily better than another property with a lower score because it depends on how much equity was put into each project at inception.
Loan-to-value ratio (LTV)
The loan-to-value ratio, or LTV, is the relationship between the value of a property and its outstanding mortgage. So if you buy a house for $300k and put $20k down to get your first mortgage, your LTV is 80%.
You can use this metric to determine whether or not an investment is worth making. An investor who wants to flip houses will look at LTVs with more scrutiny than an investor who plans on renting out their properties and keeping them as long term investments.
To calculate an investment’s LTV ratio:
Step 1: Take the total purchase price of your investment (this includes any money spent on renovations or repairs)
Step 2: Subtract this amount from the appraised value (the estimated market value)
Equity multiple
The equity multiple is the ratio of the property value to an investor’s equity.
The following equation can be used to calculate this metric:
- Property Value ÷ Investor Equity = Equity Multiple
If you’re going to invest in real estate, make sure to know the metrics.
As a real estate investor, you’re going to want to know the metrics.
What are they?
Metrics are data points that provide information on the performance of your investment property. They can show you how much your rental property is making, what types of tenants you have, and how well it is maintaining its value over time. The metrics will tell you if your investment is performing well or not so well, which in turn helps guide future decisions about when (or if) to sell the property.
Conclusion
There are many different metrics that real estate investors should know inside and out. In this article, we’ve explored some of the most important ones, including the cap rate and cash-on-cash return. We also talked about how these metrics can vary depending on factors like type of property or geographic location. Regardless of your investment goals, it’s important to make sure you understand these concepts before jumping in with both feet!
