Managing an investment property involves regularly keeping track of its performance. Whether you are operating independently or are hiring someone to do it for you, checking how your portfolio is doing is critical. Analyzing performance is required to make smart, strategic decisions. You’ll not only see if you are making a healthy profit, but gain insight into “how” and “why”. Let’s take a look at some of the real estate investment key performance indicators (KPI) that help investors see if they should unload a property to cut their losses or if it makes sense to keep it in their portfolio.
Also called the cap rate, this measures an investment property’s profitability and return potential. You can determine its value by dividing your investment property’s net operating income (NOI) by its current market value or the price.
To calculate for NOI, subtract all your expenses for operating the property from your expected annual income. While current market value refers to your property’s value based on the present-day market rates.
Cap Rate = Net Operating Income / Current Market Value
Another version of the formula replaces the current market value with the property’s purchase price. However, it cannot be applied to properties that were inherited or other scenarios where purchase price no longer reflects current value.
Take a look at Conceptualizing Cap Rates – if you want to dive deeper into this metric.
Net Operating Income (NOI)
NOI is the pre-tax difference between your annual revenue and operational expenses. It doesn’t include depreciation, amortization, capital expenditures, and loan payments. If you are coming from a finance background, you may recognize it as EBITDA (earnings before interest, tax, depreciation, and amortization). You can increase or decrease its value by deferring income or spending.
Net Operating Income = Real Estate Revenue – Operational Expenses
NOI gives you an idea of how much income your investment property is generating or if you are losing money. By comparing NOIs during a 5- or 10-year period, you’ll better understand if it’s time to sell, or if you should hold on to the property for much longer.
As a real estate investor, you also need to keep track of your cash-on-cash return, especially if your investment involves debt. This KPI refers to the annual return you make out after operating expenses, capital expenditures, and debt service. More specifically, it is the rate of the difference between the cash inflow and cash outflow you make after repaying your loan. It can also be expressed as the measure of annual pre-tax cash flow per total cash investment.
Cash-on-Cash Return (%) = Annual Pre-Tax Cash Flow / Total Cash Invested
For example, the property you want to buy is worth $1.2 million. You paid $120,000 upfront and borrowed the rest from the bank. Then, you spent about $47,000 on closing fees, maintenance costs, and other expenses. So, your cash cost basis is now $167,000.
Suppose your NOI in year 1 is $48,000. After debt service (mortgage payments) and any capital expenditures your cash flow is now $20,000. So, your cash-on-cash return is $20,000 / $167,000, which is ~12%.
Loan-to-Value Ratio (LTV)
Dividing the amount you borrowed to buy a property by the property’s value gives you your investment’s loan-to-value (LTV) ratio.
LTV Ratio (%) = Mortgage Amount / Property Value
Lenders use the LTV ratio as one (of many) criteria for approving loan applications because it tells them about the mortgage’s risk level. After all, a borrower who can’t make a sizable down payment has less at stake in the investment. The higher a borrower’s LTV ratio, the bigger the risk lenders have to take.
As an investor, you will need to assess and weigh how much debt you can take on, the risk of your investment and the potential returns. Underwriting tools like www.allow for you to iterate and analyze various options.
Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio measures your investment property’s capacity to pay your mortgage and other debts. Your goal is to have a high coverage ratio because this shows your business is financially stable.
Debt Service Coverage Ratio = Cash Flow from Operations / Total Debt
By monitoring your debt service coverage ratio, you will be able to see if you have enough operating income to “cover” your debt obligation (payments). Many lenders will have set criteria for DSCR (e.g. min DSCR of 1.2x).
Gross Rent Multiplier (GRM)
Gross Rent Multiplier is a metric that is more frequently used in smaller investments or Single Family Rentals. It is often thought of as the inverse of the cap rate (which is more prevalent in commercial real estate) although the calculation differs slightly.
The Gross Rent Multiplier is a metric that compares your investment property’s asking price to your gross rental income. You may also use the fair market value in place of your property’s asking price. The lower the GRM, the faster you can pay off your investment and start generating income.
Gross Rent Multiplier = Property Price / Gross Annual Rental Income
However, take note that this calculation doesn’t factor in the following:
- Turnovers and vacancies
Monitoring your investment property’s GRM is a quick tool to compare and assess investments..
Net Present Value (NPV)
The Net Present Value is the value of your expected cash flow in today’s dollars.
Net Present Value = Today’s Value of the Expected Cash Flows – Today’s Value of Invested Cash
A positive NPV means that the investment is profitable, and a negative one means that it’s not (at a given the discount rate). But why the present value? We assume that your money’s present worth increases over time due to inflation and potential profit from alternative investments. If your investment property’s projected costs cancel out or exceed your earnings from both inflation and alternative investments, consider it a red flag.
Internal Rate of Return (IRR)
The IRR is a measure of return that accounts for the time-value of money and is the converse of NPV. It is often what is quoted when presented with the question – “ what is the return?”. By definition, the IRR is the discount rate that equates the NPV to zero. Calculating IRR, in this case, is only possible when NPV is zero.
NPV = Net Present Value
IRR = Internal Rate of Return
CF = Initial Investment
n = Each Period
N = Holding Period
You will notice that most of these metrics show an investment property’s return rate, which raises the question of why not just use one? The truth is each of them represents a unique aspect of your investment, and it takes all of them to measure your investment’s overall performance. Smart analysis compares and contrasts various KPI’s to tell the bigger picture and assess investment potential.
There are also instances when KPIs don’t agree with one another, revealing the investment’s strengths and limits. Comparing multiple KPIs helps you make estate investments that are aligned with your risk and return expectations.
If you’re like most investors, you probably use traditional software like Microsoft Excel to model your cash flow. The problem is it takes some time to learn Microsoft Excel, and with so many factors to be considered, it’s easy to make mistakes that cost millions of dollars.
Modeling your cash flow and calculating KPIs shouldn’t be complicated and stressful. New cash flow modeling software that doesn’t require manual programming is now within reach with Money Weighted. A user-friendly interface allows for quick and easy cash flow modeling without sacrificing the robustness of Excel.