A number of factors should come into play when you debate whether or not to invest in real estate. You must ensure you can make money and recoup funds that you put into any property you buy. By understanding some of the most common metrics in real estate investing, along with consulting with us at Upside Investments, you can maximize your profits as a real estate investor.
ROI: ROI stands for Return on Investment. This metric tells you if and how much of a profit that you can make on a piece of property in which you invest. It compares the amount of money, including the purchase price, you have invested in the property to its current value. This metric is vital because it helps you determine if a piece of property is actually worth the money of buying and maintaining it. You can avoid putting money into real estate that will not garner you the income you desire from it.
Cap Rate: Cap rate, or capitalization rate, in real estate divides a real estate investment’s net operating income by its current market value. This rate is indicated as a percentage, and it estimates an investor’s potential return on a piece of property he or she buys. It should not be the only factor used, however, as it does not take into account other metrics like future cash flow, leverage or time value of money. Investors can use it to compare relative values of similar real estate investments.
Cash Flow: Cash flow in terms of real estate relates to the money that an investor moves in and out of a property that he or she buys. To find out how much is in an investor’s cash flow, this person should subtract all of the investment’s expenses and cash reserves from any income that the property generates. It essentially tells an investor how much, if money, he or she has left over after paying for costs like upkeep, repairs and upgrades to real estate in which he or she has invested.
NOI: NOI stands for Net Operating Income. It is a method that real estate investors can use to value any properties that are meant to generate income for them. To determine NOI, you deduct the operating expenses from the pre-tax income that a property generates for you. NOI does not take into account expenses like:
- Loan principle or interest
- Capital expenditures
- Amortization
- Depreciation
NOI tells investors if a rental property is worth the costs of owning and maintaining it.
Operating Expense Ratio: An operating expense ratio for real estate investors compares the costs of owning and operating real estate to the income that it generates for the investor. It divides the property’s operating expenses, minus depreciation, by its gross operating income. An operating expense ratio comes in useful for comparing the expenses of properties that are similar to the one in which a person has already invested. Investors can shape their real estate portfolios accordingly based on the results of a property’s operating expense ratio.
Capital Expenditures: Capital expenditures are the costs that a real estate investor incurs for improving upon or adding on to a piece of property. These costs go beyond regular repairs and maintenance. They include expenses for projects specifically designed to upgrade, significantly repair or extend the life of a real estate investment, such as a building or plot of land. Capital expenditures can vary from property to property and largely depend on factors like the size and age of an investment. However, most investors purposely set aside funds from their monthly revenues to cover capital expenditures.
Cash-on-cash Return: Cash-on-cash return for a real estate investor refers to the rate of return in real estate transactions that utilize cash rather than other sources of funding. It essentially tells an investor if he or she has made a lucrative return on the cash that he or she has put into a real estate investment. It is indicated as a percentage. Cash-on-cash return also measures the rate of return that an investor makes on a property compared to the amount of money that he or she has paid into the property’s mortgage for that year.
Gross Rent Multiplier: Gross rent multiplier is a useful metric that allows owners of rental properties determine if they are making solid incomes. It is a ratio that shows a property’s market value over its gross yearly rental income. Investors can use gross rental multiplier to compare rental property opportunities. This metric lets them analyze any properties they have invested or want to invest in without having to bother with complete analyses. It can also tell a real estate investor if a property is overpriced or could have issues making him or her money.
Debt Service Coverage Ratio: A debt service coverage ratio, or DSCR, is a real estate investment metric that measures the net operating income from a property and divides that income by the property’s total debt service. It shows if an investor can repay or service a debt like a mortgage from the income that an investment generates for him or her. Lenders like banks use this ratio to weigh its risk and profitability before lending to an investor. Most financiers prefer a DSCR of 1.25 to 1.5.
Internal Rate of Return: The internal rate of return on a real estate investment indicates the rate at which the property’s net present value and future cash flow from it equals zero. It also indicates the rate of interest or the growth of the investment that it is expected to generate during the time the investor owns it. It is designed to tell investors whether or not they should proceed with buying a piece of property or forgo it because it will not generate a good enough return for them.
These metrics are a few that should come into play for real estate investors like you. You can learn more about these and other real estate investing metrics today when you contact us at Upside Investments.
