Starting your real estate investing journey can be daunting. You’re first google searches may include “how to build a real estate portfolio,” “real estate investing for beginners,” or “the best real estate investing books.” All of which will open your eyes to an entirely new language of acronyms, calculations and property assessment methods. Here are some of the most common REI buzz words and metrics to help sharpen your investor skills.
Net Operating Income (NOI) – The total income of a property minus the operating expenses. The mortgage is never considered an operating expense; however, do not forget to include the property taxes and any fees incurred from using professionals (such as property management or legal). NOI is a great “quick glance” at potential income, but is not always accurate. This approach is simply to understand a property’s ability to generate revenue/profit.
Cash-on-cash return (CoCR) – The return you would get on your money if you bought in cash. This is calculated by dividing the NOI by initial investment in the property. CoCR can be helpful in determining whether a property meets your profitability goals. It can also help you pinpoint the right financing method (such as traditional mortgage vs private lender).
Internal Rate of Return (IRR) - The adjusted return for the timing of cashflows (incl. sale/refi). In other words, the interest you will earn on each dollar invested on a rental property over its holding period. This formula is much more comprehensive than the previously mentioned approaches to assessing potential property performance and current property performance. For this reason, most investors utilize the IRR function in Excel to calculate the ratio.
Capitalization (Cap) Rate – Divides NOI by the asset value. This essentially tells you what percentage of the investment’s value is profit. The higher the percentage, the higher the risk.
Net Present Value (NVP) - the difference between the present value of cash inflows and the present value of cash outflows over a period of time. Investor’s typically use Excel’s NVP formula. The calculation helps determine how much value an investment will add to a portfolio.
Cashflow – Simple but important. It is a sign of how well your business is doing and is the return on your money just factoring cashflow (if you never sold or re-financed).
Gross Rent Multiplier (GRM) – Property price divided by its gross rental multiplier. The lower the GRM, the better! However, utilize local comps to determine a good GRM. *We do not recommend purchasing because of this.
Debt Service Coverage Ratio (DCR) - The ability to pay your debt. Lenders typically want >1.25. You don't want to be over-leveraged. Formula: (NOI + Insurance + Taxes)/(Loan Principle, Interest, Mortgage Insurance & Taxes)
Loan-to-Value Ratio (LTV) – Compares the amount of the mortgage against the appraised value of the property. The higher the down payment, the lower the LTV.
Operating Expense Ratio (OER) – Assesses how well expenses are being controlled relative to income. One of the few ratios that includes depreciation. Can be indicative of whether rent increases have kept up with expense increases.
Return on Equity (ROE) – The measure of net income / equity. Gauges profitability and efficiency. Higher ROE suggests the property efficiently generates income.
Each of these methods provide a purpose and a story but should not stand alone. Think of these metrics as puzzle pieces and utilize them within the context of the local market, property condition, and your investment goals as a whole.