Real Estate 101
Real Estate Investing Metrics
Defining the most important real estate investing metrics.
If you’re thinking about making a real estate investment, here are the most important terms and metrics to know.
Net Operating Income
Net operating income (NOI) essentially refers to the money you make from a property, and it’s one of the easiest metrics to calculate on your own. You simply subtract your operating expenses (excluding mortgage payments, business taxes, and interest) from your total yearly income.
Gross Operating Income
Gross operating income (GOI) is calculated by subtracting the estimated cost of vacancies or non-payment from the gross potential income (i.e. how much the property could make if units are full year-round).
Arguably one of the most important real estate investment metrics, cap rate, or capitalization rate, shows the potential return on a property. You can find the cap rate by dividing the NOI by the property’s cost. Generally the lower the cap rate, the less ‘risky’ the investment.
Loan to Value Ratio
If you’ve ever taken out a business loan, this one will be familiar. To find the LTV, you divide the loan amount by the property to produce a ratio. For reference, the majority of lenders require an LTV of 65%-80%. As an example, an 80% LTV requirement would mean that a loan seeker would need to either purchase the property at 20% below its market value or have a 20% down payment in hand.
Internal Rate of Return
Internal rate of return (IRR) can help investors judge a property’s ability to turn a profit. It takes into account several factors to provide a fairly accurate picture of whether a property is making money or not.
Cash on Cash Return
Cash on cash return (CCR) is a way to evaluate how an investment is performing. It divides the before-tax cash flow by the total cash invested to show how much money the invested cash is bringing in. This metric isn’t perfect by any means since it leaves any debts and other expenses out of the equation.
Debt Coverage Service Ratio
Also known as debt coverage ratio (DCR), debt coverage service ratio (DCSR) shows whether a property is bringing in enough to stay in the black. You find it by dividing NOI by annual debt service. A DCSR rating of less than 1 shows that a property has a negative cash flow and can’t cover expenses.
Operating Expense Ratio
This metric can help investors get a picture of how much it will cost to operate a property so they can judge its value as an investment or compare it to other potential investments. It can also help gauge how well property management is handling expenses and keeping cash flowing in. To calculate the operating expenses ratio (OER), you divide operating expenses by the potential rental income.
Gross Rent Multiplier
Gross rent multiplier (GRM) divides a property’s value by gross rents to compare a property’s income potential to similar properties. You can use this formula to estimate the price you should pay for a property, as well.
Being familiar with these metrics can help make the journey into real estate investment so much smoother, from the bank to the brokerage to running your business every day. Need help understanding what these metrics mean for you as you look to pull cash out of your commercial real estate investment? Feel free to reach out to us here at Keyway!
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