There’s more to selecting an investment property than the purchase price and possible rental income. Investors have developed a library of ratios and computations to assist them invest wisely and avoid risk while maximizing reward. Savvy investors master these real estate investing indicators so that they can quickly assess a possible investment and keep track of their current holdings. These measurements are oriented toward residential investments, but if you’re looking to invest in commercial property, check out this page.
These are the top ten real estate investing metrics you should know, whether you’re a rookie investor or someone with twenty years of experience who needs a refresher, comprar departamento playa del carmen. Instead, you may see this article as a slideshow, download The Top 10 Metrics Every Real Estate Investor Should Know as a PDF, or watch the webinar video.
1. Operating Income (Net) (NOI)
The net operating income (NOI) of a certain investment property tells you how much money you make. It’s a simplified version of a profit and loss statement. To figure it out, remove your operational expenses from your total income. Mortgage payments should never be included in the NOI calculation because they are not considered operating expenses.
Don’t forget to factor in income from laundry machines, extra parking fees, and any other service fees when calculating your overall income. Property manager fees, legal fees, general maintenance, property taxes, and any utilities you pay are all examples of operating expenses.
Capital expenses, taxes, mortgage payments, and interest are not included in the computation. Remember that expected rents may prove to be wrong when utilizing NOI to analyze a possible investment. In addition, if the facility is mismanaged, income may be inconsistent. You can conduct this calculation yourself or have Stessa do it for you.
What is the significance of Net Operating Income?
NOI is the only metric used by investors to assess a building’s ability to generate income and profit. It determines if a particular investment will create enough income to cover your mortgage obligations.
Check read our post on What is Net Operating Income? for a real-life case study with NOI estimates and more information.
2. Rate of Capitalization (Cap Rate)
The real estate equivalent of the stock market’s return on investment is the cap rate. It’s the proportion of income generated by a property to the initial capital invested (or its current value). It specifies the profit as a percentage of the investment’s total value.
The capitalization rate is calculated by dividing your net operating income (NOI) by the asset value. This is the property’s sale price when you’re in the acquisition phase. Later on, you can use a local realtor, broker, or the estimated value on real estate websites like Zillow to determine the value of your home. You can conduct this calculation yourself or have Stessa do it for you.
What is the significance of Cap Rate?
The higher the cap rate, the bigger the risk, in general. This is due to the fact that a high cap rate signals larger profits and, as a result, higher risk. This is why riskier markets have higher cap rates, whereas stable and larger markets, such as New York City or San Francisco, have lower cap rates.
3. Return on Investment (IRR)
IRR calculates the amount of interest you’ll earn on each dollar you invest in a rental property throughout the course of its ownership. It’s the potential for a property to grow at a certain rate. To determine long-term yield, the computation goes beyond net operating income and acquisition price.
Set the property’s net present value (NPV) to zero and utilize predicted cash flows for each year you plan to keep the building when calculating IRR. Net present value is the difference between the current worth of money and the future value of money after compound interest has been added. Because the method is difficult, most investors utilize Excel’s IRR function to determine the ratio.
While IRR is commonly used by investors to compare properties, you should be aware of its limits. It is presumptively based on a steady rental environment and the absence of unforeseen maintenance. The properties you’re comparing should be similar in terms of size, use, and time on the market.
What is the significance of IRR?
A common IRR measure varies from 10-20 percent depending on the exact real estate asset, but it can vary substantially. It’s another another useful metric for determining whether a property is operating effectively for you.
4. Flow of Cash
Cash flow is an indicator of how successfully – or poorly – your company is doing. It’s the money you have left over at the end of the month after you’ve paid your bills and collected your rent. Your net cash flow is $800 if you rent a building for $2,000 per month and your total costs are $1,200. You can conduct this calculation yourself or have Stessa do it for you.
What is the significance of cash flow?
The term “net cash flow” refers to a quantity that is both simple and important. You won’t be able to pay your payments or generate a profit if it’s negative. Negative cash flow can also suggest that you’re overspending on the property, therefore you should look at the costs linked with it. Alternatively, you may have a delinquent tenant whose late or partial payments are negatively harming your financial situation.
5. Return on Investment
The overall return on the money you have in your real estate investment is known as cash on cash return. Simply simply, it’s the amount of money you make from your money invested. It’s significant because, unlike other real estate investing indicators, it incorporates debt service and your mortgage payment.
Take your net cash flow after debt service and divide it by the total cash in the deal to find the current return on the total amount of cash in either a property or your portfolio. To compute total cash in, add the building’s or portfolio’s purchase price plus closing fees, remove the outstanding mortgage debt, and then add any capital expenditures. You can conduct this calculation yourself or have Stessa do it for you.
What is the significance of Cash-on-Cash?
Experimenting with cash-on-cash returns can assist you in determining the optimal approach to fund a new investment. It can assist you in deciding between potential investments and forecasting returns during years when capital expenditures are expected.
6. Multiplier for Gross Rent (GRM)
GRM assists investors in comparing buildings and estimating a building’s value. It’s computed by multiplying the price of the property by the gross rental income. Your local market and comparable homes will determine what constitutes a “good” GRM.
You can either utilize a projected gross rental income or request a copy of the existing owner’s rent roll. You wouldn’t base an investment choice purely on GRM because it ignores vacancies and expenses. You can conduct this calculation yourself or have Stessa do it for you.
What Is the Importance of GRM?
The lower the GRM, the better, but you can expect one to be in the range of 4-8. This will assist you in determining whether your possible deal is a good investment or whether an existing asset is worth keeping on to in the long run.
LTV Ratio (Loan-to-Value Ratio)
The Loan to Value Ratio is a metric that determines how much leverage a certain asset has. An LTV is important for buyers who finance their purchases since it calculates the amount of money you’ll need to borrow based on the property’s current fair market value. However, LTV is the most accurate approach to assess the amount of equity you have in a property (not just for financing), as well as the worth of your portfolio and assets when debt is factored in.
Most lenders will not lend up to 100% of a property’s worth because they want to safeguard their investment by leaving equity in the property. In a loan-to-value ratio, they express how much of the overall purchase price they’re willing to fund.
The amount of money you’ll have to pay into the deal is the difference between the percentage a lender will finance and the overall worth of the property.
What Is the Importance of LTV?
If the lender will lend up to 80% LTV, you’ll need a 20% down payment to get the loan. In this case, a $100,000 property would require a $20,000 down payment plus closing expenses, resulting in an LTV of 80%. If the home is now worth $200,000 and you’ve paid down your mortgage to $50,000 after ten years, your LTV is now 25%.
Debt Service Coverage Ratio (DSCR):
Your Debt Service Coverage Ratio, or DSCR, is also important to lenders. It compares the amount of operating income available to service debt to the total amount of debt you have. To calculate your DSCR, divide your net operating income by debt payments on a monthly, quarterly, or annual basis.
Lenders use your DSCR to determine your repayment capabilities when you apply for a new mortgage. A high ratio suggests that you may be too leveraged, making it more difficult to obtain funding.
What Is the Importance of DSCR?
A DSCR of 1.25–1.5 is required by most A and B lenders. This means that after debt service, your rental property generates a 25% increase in additional income. A DSCR of 1.5-1.75 is even better, and could help you save money on interest.
9. Ratio of Operating Expenses to Revenue (OER)
The OER is a profitability indicator that informs you how well you’re controlling spending in relation to revenue. To calculate your OER, add all operating expenses, minus depreciation, and divide by operating income. It’s one of the few investor-friendly ratios that incorporates depreciation, making it more inclusive of property expenditures. You can conduct this calculation yourself or have Stessa do it for you.
What is the significance of open educational resources (OER)?
A lower OER indicates that you’ve cut costs in relation to revenue. If your OER has been steadily increasing over time, it could suggest a variety of problems. Perhaps annual rent hikes haven’t kept pace with rising expenses. Alternatively, your management business may not be keeping up with normal maintenance, resulting in more major issues in the future. Calculating OER using specific spending will help you pinpoint the source of the increase and get it under control.
Occupancy Rates (No. 10)
Even though an unoccupied unit does not generate any revenue, it still costs you money. Even if you don’t have any tenants, many running expenditures stay the same. To keep an eye on open units and lost income, most investors check two historical occupancy rates.
Vacancy Rate in Physical Space
When compared to the total number of units available, this rate tells you what percentage of your apartments are unoccupied. It’s simple to figure out: multiply the number of vacant units by 100 and divide by the total number of units. This statistic can be applied to individual properties or to your entire portfolio.
Vacancy Rate in the Economy
When a unit is vacant, the economic vacancy rate calculates how much money you’re losing. To figure out how much the vacancy cost you, add up the rents lost during the vacancy period and divide by the total rent that would have been received in a year.
What is the significance of the Vacancy Rate?
It’s a good idea to keep an eye on your own vacancy rates as well as the occupancy rate of the general market. Build that rate into possible income calculations before purchasing a new building to be safe. All of your spending calculations should include a 5-10% vacancy buffer to guarantee that you can cover all expenses if units go unrented. You can calculate this metric yourself or have Stessa perform it for you each time.