Performance Metrics You Need to Know
When it comes to real estate investment property analysis, investors evaluate and compare important metrics between properties to help guide decisions. Here are 5 important metrics every investor should look at:
Return on Investment (ROI)
Net Operating Income (NOI)
Capitalization Rate (Cap Rate)
Internal Rate of Return (IRR)
Let's dive into each of them...
Cash-on-cash return is a simple and extremely useful financial calculation that real estate investors use regularly. COC measures the net cash flow a property generates as a percentage of the total cash invested.
Annual pre-tax cash flow net of debt payments / Total cash invested = COC
Example: $10,000 pre-tax cash flow with a total cash investment of $100,000.
$10,000/$100,000 = 10% COC
Return on investment literally measures the return of an investment compared to its cost.
(Current Market Value – Cost of Investment) / Cost of Investment = ROI
Example: $250,000 current market value with a $150,000 original purchase price.
($250,000 - $150,000) / $150,000 = 67% ROI
Net operating income is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses. Operating expenses excludes mortgage payments, capital expenditures, depreciation/amortization and income taxes. NOI is best calculated annually to capture all operating expenses you might experience throughout the year.
Income - Operating Expenses = NOI
Example: $100,000 - $70,000 = $30,000 NOI
4. Cap Rate
The capitalization rate is a quick measurement of your rate of return on an investment. It is a useful tool to compare properties within the same market or between markets. The cap rate formula helps you determine the market value of a property under consideration for purchase and how it performs after the acquisition.
NOI / Market Price = Cap Rate
Example: A property’s market price is $1,000,000 with an NOI of $50,000.
$50,000 / $1,000,000 = 5% Cap Rate
Time is money, especially when investing in real estate. Internal rate of return measures annualized percentage return using all net cash flows received for the duration of the investment. The longer your money is tied up, the lower the IRR will likely be. The formula for calculating IRR is complex and requires the use of a financial calculator, spreadsheet program, or specialized calculator.
Metrics provide a guide to real estate investors and helps you make informed decisions on whether a property meets your criteria.
Which properties should you purchase at what time?
How well are you managing the properties you own?
When should you sell to lock in your return?
Each metric tells you something different. Be aware of what metrics are important to you and the story you want your property to tell. Be informed to be successful!