9 Real Estate Metrics Every Investor Should Know
In real estate, as in any other field, it’s important to know your financial metrics. The more you know about the ins and outs of the industry, the better equipped you are to make sound investment decisions. Any given real estate metric is different as compared to other industries in its implication.
But what are the most important real estate metrics for investors? And how do you go about calculating them?
In this article, we’ll explore the top 10 real estate metrics every investor should know. We’ll also provide instructions on how to calculate each metric. So read on to learn everything you need to become a savvy real estate investor.
1. Cash on Cash Return
The cash on cash return is considered one of the most important real estate metrics for investors to understand. It gives an absolute rate of return based on the cash flow of a property.
The net amount of money that has come into the business or gone out of it, specifically from operating activities.
Cash on Cash Return Formula = Net Operating Income/Total Investment
Example: A rental property generates $100,000 in gross income with expenses totaling $75,000 leading to a net income of $25,000/Total Invested Capital=25%.
At any point, if you think you are not making the right calculations or missing something out, you can easily reach out to the financial analysis experts at Oak Business Consultant.
2. Gross Rent Multiplier (GRM)
The gross rent multiplier, or GRM, is an absolute measure of the relationship between how much it costs you to buy a property and the revenue that the property can produce.
Gross Rent Multiplier Formula = Purchase Price/Net Rental Income
Example: A property with purchase price $150,000 has net rental income of $10,000. The gross rent multiplier for this property would be $150,000/$10,000=15
The number ’15’ used in this example is ideal and also a dream for many real estate investors. Usually, this number falls somewhere between 6 and 9. And if you are looking to make your real estate investments with higher GRM, you should consider an expert’s prepared real estate financial model.
3. Capitalization Rate (Cap Rate)
When talking about real estate, it’s impossible to leave out the capitalization rate, or Cap Rate. It’s also one of the most important metrics for real estate investors to understand. The cap rate is the rental income earned from a property, expressed as a percentage of its total value.
Capitalization Rate Formula = Annual Net Operating Income/Total Market Value
Example: A rental property produces $10,000 in net operating income and has a market value of $150,000. The capitalization rate would be ($10,500/$150,000) x 100%. So the cap rate for this property would be 7%.
4. Internal Rate of Return
Many people have no idea how the internal rate of return (IRR) works, and that’s a big mistake. While you might not have much time in the real estate investing game, the IRR is something every serious investor should at least be able to understand. IRR is one of the most powerful, yet underutilized, tools to help determine the potential ROI for your investment. It’s also a critical metric for determining a property’s true value.
The first thing to do is to define the terms “time value,” “discount rate,” and “Internal Rate of Return (IRR).”
The discount rate is a simple concept. It represents the percentage of a cash flow that investors are willing to pay in order to make a capital investment.
IRR is a slightly more complicated concept. It is the rate of return (in percentage terms) that an investor is willing to receive from their capital investment. In other words, IRR is the amount of money they will get back in a year or other investment period.
The IRR is usually determined by calculating the future cash flows (the difference between the current value of the investment and the final sale price) and dividing the net present value (the value of all future cash flows) by the initial investment amount.
5. LTV (Loan to Value Ratio) Real Estate Metric
A Loan to Value Ratio measures how much leverage is applied to an asset. The LTV is important to buyers who finance their deals because it determines how much you’ll need to finance based on the property’s current fair market value. But LTV is also a good measure of how much equity you hold in a property (not just for financing), but for the value of your portfolio and assets when including debt.
Most lenders will not finance 100% of the value of a property; they want to protect their investment by leaving some equity in it. A loan-to-value ratio indicates how much of the total purchase price they’re willing to finance.
You will have to put money into the deal based on the difference between the percent a lender will finance and the property’s total value.
What is the importance of LTV?
To secure the mortgage with 80% LTV, you will need to make a 20% down payment. Assuming 80% LTV, a $100,000 property would require $20,000 as a down payment and closing costs. If your property value has increased to $200,000 after 10 years, and your mortgage has been paid down to $50,000, your LTV is now 25%.
6. Debt Service Coverage Ratio
As a real estate investor, you should also pay attention to your Debt Service Coverage Ratio. You can compare how much operating income you have available for servicing debt with how much overall debt you have. You can calculate your debt service coverage ratio by dividing your net operating income by your debt payments, either on a monthly, quarterly, or annual basis.
When you are applying for a new mortgage, lenders will use your DSCR to determine your repayment ability. The higher the ratio, the more likely it is that you are too leveraged, and this will make it more difficult for you to qualify for financing.
How Does the DSCR Real Estate Metric Affect You?
The normal DSCR for A and B lenders is in the range of 1.25-1.5. This means that your rental property provides an additional 25% of revenue after debt service after you have paid off the loan. This is even more desirable and could help in lowering your interest rate if you achieve a DSCR of 1.5-1.75.
7. Operating Expense Ratio (OER)
OER measures how well you’re controlling expenses as compared to income. Divide all operating expenses, minus depreciation, by operating income to determine your OER. It is one of the few ratios used by investors to account for depreciation, which makes it more accurate. If you want the most accurate calculation for this metric or any other, you can quickly reach out to our financial planning experts.
OER: Why is it Important?
The lower your OER, the lower your expenses are compared to your revenue. Increasing OER over time could indicate many issues. It is possible that rent increases may not have kept pace with expenses. Alternatively, you may not be performing routine maintenance, leading to more serious problems in the future. You can narrow down the cause of OER growth by calculating it using specific expenses.
8. Occupancy Rates
You still pay for an unoccupied unit even though it generates no income. You may still incur operating costs even if you do not have tenants. In order to keep an eye on open units and lost income, most investors track two historical occupancy rates.
Physical Vacancy Rate
You can use this rate to determine the percentage of vacant units compared to the total number of units. The formula is simple: multiply the number of vacant units by 100, and divide by the total number of units. On a property-by-property basis, or across your entire portfolio, you can use this real estate metric.
Economic Vacancy Rate
A vacant unit will result in a loss of income, which is the economic vacancy rate. If you add up the rents lost during the vacancy period and divide them by the total rent that would have been collected in a year, you’ll get what the vacancy costs you.
Vacancy Rate: Why is it Important?
Keeping an eye on your own vacancy rates, as well as your market’s, is always a good idea. When calculating potential income before purchasing a new property, include that rate. Ensure you build a buffer of 5-10% vacancy into your expense calculations so that you can cover all expenses if a unit does not rent. You can also make use of our apartment rental financial model if you want to get into the rental business professionally.
9. Net Operating Income (NOI) – Important Real Estate Metric
An investment property’s NOI shows how much money you will make. An income statement for the larger picture. Total income minus operating costs equals NOI. Mortgage payments are not considered operating expenses, so don’t include them in this real estate metric.
Include laundry machine income, parking fees, or other service fees in your total income. You are responsible for paying utilities as well as property management fees, legal fees, general maintenance, and property taxes.
Interest, taxes, and mortgage payments are not included in the calculation. You should keep in mind that projected rents could be inaccurate when using NOI to evaluate an investment. A poorly managed building could result in inconsistent income.
What is the Significance of Net Operating Income – A Real Estate Metric?
Investors in real estate solely rely on NOI as a measure of a building’s capability to produce revenue and profit. It is important to know whether a specific investment will generate enough income to be able to pay your mortgage.
Why Hire Oak Business Consultant as Your Financial Analyst?
We provide the best financial analyst services to all real estate investors and developers to help them make smart real estate investing decisions. We use the most advanced data available to us, coupled with our proven methods, to create a financial plan that is tailored to you and your needs. You will be able to see clearly the true cost of the real estate you are buying so you can make an informed decision based on your own numbers, not someone else’s.
Relevant to the real estate industry, we provide the following services along with our expert financial analysis:
- Real Estate Financial Modeling
- Business planning for Real Estate investors
- Real estate Investor Pitch Deck Templates