Understanding the key financial metrics for evaluating your real estate investment is essential for your long-term success. Shooting from the hip and making investments on gut feeling is extremely risky. Consider these metrics as your performance indicators. If you can’t tell how a property is performing, learn, and understand the following financial metrics.
We want to start out with everyone’s favorite — the Cap Rate. The capitalization rate indicates the rate of return that is expected to be generated on a real estate investment property.
Formula for cap rate is:
Capitalization Rate = Net Operating Income / Current Market Value
Net Operating Income or (NOI) is the annual income generated by an income-producing property after taking into account all revenue collected from operations and deducting all expenses incurred from operations.
The Formula for NOI is:
Net operating income = Real Estate Revenue – Operating Expenses
Gross Operating Income (GOI) is the result of subtracting the credit and vacancy losses from a property’s gross potential income. GOI is also sometimes known as Effective Gross Income or (EGI).
The Formula for Effective Gross Income
EGI = Potential Gross Rental Income + Other Income – Vacancy & Bad Debt Allowance
Cash-on-Cash Return is the equity dividend rate, it refers to the rate of return on real estate investments, and it is calculated by dividing the cash flow before tax over the equity invested.
The Formula for Cash-on-Cash Return:
Cash-on-Cash Return = Annual Pre-tax Cash Flow / Total Cash Invested
Loan-to-Value Ratio (LTV) describes the size of a loan you take out compared to the value of the property securing the loan.
The Formula for LTV:
LTV ratio = Mortgage amount / Appraised Property Value
Debt Coverage Ratio or debt service coverage ratio measures the ability to pay the property’s monthly mortgage payments from the cash generated from renting the property.
The Formula for Debt Service Coverage Ratio:
DSCR = Net Operating Income / Total Debt Service
Gross Rent Multiplier (GRM) is A capitalization method used for calculating the approximate value of an income-producing commercial property based on the property’s gross rental income. The gross rent multiplier can help narrow down the best opportunities in the market for an investment property.
The Formula for calculating GRM:
Gross Rent Multiplier = Market Value / Annual Gross Income
Operating Expense Ratio (OER) is the measurement of the cost to … all operating expenses less depreciation by operating income.
The Formula for OER is:
OER = Total operating expenses – depreciation / gross revenue
Gross potential income (GPI) is the maximum amount of income a property would produce when 100 percent of the rental space or units are leased at the full market rental rate in any given market.
Tracking and comparing relevant metrics will help improve your overall real estate investment performance. By knowing the numbers and doing your due diligence, you can truly gauge how your real estate asset “is” performing or “will” perform in any given market. If you have any questions or would like to connect, feel free to reach out to The Listing Real Estate Management, Orlando’s Best Property Management Provider.
