Numbers drive real estate investment decisions. The question is, which metrics matter?
New real estate investors often become confused with the countless methods to evaluate an investment as well as the industry acronyms. Depending on the investment goals and property type, some metrics carry more weight than others. Here are a few of the most important metrics to understand
Capitalization Rates
Talking about real estate investing without capitalization rates is next to impossible. Referred to as cap rates, this metric estimates the investors’ potential returns on a property. Use cap rates to compare similar properties in different markets. Cap rate is calculated by dividing annual net operating income by the cost of the asset (or its current value). As cap rates go up, the return on your investment goes down.
- Capitalization Rate= Annual Net Operating Income/ Property Value or Cost
Net Operating Income
NOI measures a property’s ability to generate a positive cash flow from operations.
- Net operating income = Gross operating income – Operating expenses
Gross operating income
For income-producing real estate, the gross operating income is the total income received from rentals and services before any costs or expenses are subtracted. The GOI is determined by subtracting the vacancy and credit losses from the gross potential income of the property. Another term that can be used for GOI is effective gross income as it refers to the effective gains of the property without the losses from vacancies.
Operating expenses
These expenses are the costs of running and maintaining the property, including property taxes, maintenance and repair, insurance, utilities, licenses, supplies, and overhead costs, such as expenses for accounting, attorneys and advertising.
Internal Rate of Return
IRR estimates the interest you’ll earn on each dollar invested in a rental property over its holding period. It’s the rate of growth that a property has the potential to generate. The calculation goes beyond net operating income and purchase price to estimate long-term yield.
Cash on Cash Return
CoC tells you the total return on the money you have in your real estate investment. Simply put, it’s how much money you’re earning off your cash invested.
- Cash on Cash Return= Annual pre-tax cash flow/ total cash invested
Equity Multiples
Equity Multiple is the initial investor’s capital amount invested into a deal. That capital equals the amount of equity an investor has in the passive investment. Thus, the term Equity Multiple simply means the amount your capital (or equity) will be multiplied by the end of the deal.
If a real estate syndication deal has an equity multiple of 2x and a projected hold time of 5 years, that means investors can expect to double their capital (original investment) in that 5 year period. The equity multiple is the total of the cash flow distributions plus the returns after the sale of the asset.
Conclusion-
There are tons of interesting metrics that are available to real estate investors. Understanding how these main metrics are calculated will in turn help you make informed decisions to meet your investment goals. To learn more about investment offerings at Waypoints Equity, make sure you’ve signed up for our newsletter and investor club at WaypointsEquity.com.
