Real Estate Investing Basics

Investors: Memorize These 11 Real Estate Metrics Now

Expertise: Mortgages & Creative Financing, Business Management, Landlording & Rental Properties, Commercial Real Estate, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Personal Development
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Despite what many of us math-allergic folk would prefer, real estate investments do require some math. You have to know your real estate metrics to succeed! What's a good investment? What's a bad investment? If you don’t crunch the numbers, you’ll never know.

Luckily, most of the formulas are simple and straight-forward. In fact, if you can master the calculations below, you should be just fine.

Successful investing requires accurate, easy-to-understand information about your properties and the markets you invest in. BPInsights gives you the information you need to find your next great deal and maximize your current investments—from expert analysis to proprietary data sets. Start leveling up your investments today.

Capitalization Rate (Cap Rate)

Used for: Apartment complexes and large commercial buildings

Net operating income (NOI) / total price of the property

Example:

  • NOI: $25,000
  • Total price (purchase and rehab): $300,000

$25,000 / $300,000 = 0.083, or an 8.3 percent cap rate

Cap rate is primarily used to value apartment complexes and larger commercial buildings. It can be used for houses and small multifamily too, but operating expenses are erratic with houses—after all, you won't know how often and how bad your turnovers will be.

Cap rate allows you to compare properties in a similar asset class with differing characteristics that make a direct comparison impossible. For example, let’s say you’re comparing two apartment complexes. Building A is a 100-unit apartment complex with 75 one-bedroom units and 25 two-bedroom units that average 750 square feet. Each unit has old, wooden windows and central air and heat and the apartment complex has an onsite laundry room and a community swimming pool.

Building B is an 80-unit apartment complex with 20 one-bedroom units, 50 two-bedroom units and 10 three-bedroom units averaging 900 square feet. Each unit has vinyl windows and washer/dryer hookups—but only a furnace and window unit air conditioning. There is no swimming pool, but each tenant has a carport.

Comparing Building A and Building B is much more difficult than comparing two single-family homes. Enter the cap rate, which takes the actual income those buildings produce, subtracts the expenses, and divides it by the total cost. This is a great tool for comparing large assets, as long as they are in a relatively similar class and location.

Look for a cap rate that equals or exceeds that of comparable nearby buildings. Personally, I aim for an eight percent cap rate or better, although that’s impossible in some areas. Always be sure to use real numbers or your own estimates when calculating cap rate. Do not simply use what’s on the seller-provided pro forma—or, as I call them, pro-fake-a.

The disadvantage is that a cap rate is only a snap shot. It says nothing about the expected growth in rents, expenses, or property value. It also says nothing about whether using leverage will increase your return.

Learn more: Cap Rate: A Must-Have Number for Rental and Commercial Investors

Cash Flow

Used for: Rental properties

Total income – total expenses

Example:

  • Monthly rent: $1,200
  • Monthly expenses: $1,000

$1,200 – $1,000 = $200 monthly net cash flow

When evaluating rental properties, it’s essential to work out ahead of time your expected monthly cash flow. And you’ll need to look at the big picture—not just the simple numbers. After all, it's easy to subtract your mortgage payment from the rental income and think, "Ta-da! Positive cash flow!"

Not so fast. When determining your total expenses, make sure to include things like:

  • Property taxes
  • Hazard insurance
  • Flood insurance
  • Water
  • Sewer
  • Garbage
  • Electricity
  • Property management
  • General maintenance and upkeep
  • Capital expenditures
  • Vacancy rate.

Need help sorting out cash flow? Check out our rental property calculator.

Learn more: When It Comes to Your Rental Portfolio, How Much Cash Flow Is Enough?

Return on Investment

Used for: Understanding how well a deal performed

Gain on investment – cost of investment / cost of investment

Example:

  • Investment: $100,000
  • Gain: $150,000

($150,000 – $100,000) / $100,000 = 50 percent return on investment

Return on investment is beneficial for analyzing how well a deal did in the past. This type of measurement is always important: You can’t fine-tune your future investing unless you know how your previous investments performed. Of course, when using ROI to analyze whether or not to buy a property, it’s only as good as your assumptions you put into it.

It’s important to look at this number in context. Looking at our example: 50 percent return on investment sounds great. But if it took you 50 years to make that kind of return, that’s not so great. You can get an annualized return on investment rate by simply dividing your ROI by the number of years you had the investment. In the above case it would be 50 percent / 50, which equals a one percent annual ROI.

Learn more: How BRRRR Increases Your ROI (and Why You Should Be Using It)

Internal Rate of Return

Used for: Getting into detail about how an investment performed

Pro tip: Calculating IRR is best left to a calculator.

Let’s say you are looking at a deal with the following assumptions:

  • Purchase price and costs to close: $200,000
  • Leverage: None
  • First year net operating income: $20,000
  • Annual growth rate of net operating income: 2%
  • Year five capital improvements, such as a new roof or HVAC: $50,000
  • Disposition price minus costs (end of year 10): $300,000

You can do this calculation in a spreadsheet using the formula =IRR() or you can use one of the many IRR calculators online, such as this one. With these numbers, you’ll find that your IRR equals 11.21 percent—before tax of course.

For the most precise evaluation of how an investment performed, we turn to the IRR. This can be a very powerful calculation, because it accounts for the variability of future cash flows—and for the fact that money invested sooner is worth more. Think about it this way: Would you rather have $10,000 today or five years from now? If you have the money now, you can invest that $10,000 and make a healthy return for five years. Thus, money now is worth more than money later.

So what the IRR is calculating is what your “annual effective compounded return rate” is, or in other words, what your average return is when taking into account when you have cash inflows and outflows.

Now here’s why this is important. Let’s compare that number we calculated to your ROI. The total of your return is $468,994. So if we calculate the ROI, we’ll find that it’s more than two percent higher than the IRR. What’s the reason? A large chunk of the money came in at the end, when the property was sold. As we noted above, money is worth more now than later, so your internal rate of return is reduced. The IRR accounts for when money comes in and out, whereas the ROI does not.

Learn more: Introduction to Internal Rate of Return (IRR)

Rent/Cost

Used for: Single-family homes and small multifamily properties

Monthly rent / total property price

Example:

  • Monthly rent: $1,000
  • Total property price (purchase and rehab): $75,000

$1,000 / $75,000 = 0.0133 or a 1.33 percent rent/cost

This is a great calculation for houses and, sometimes, small multifamily apartments. That being said, only use this calculation when comparing the rental value of like properties. Do not compare the rent/cost of a Class C property to one in a gated community. A roof costs the same, square foot for square foot, in both areas, but vacancy and delinquency will be higher in a bad area. Here, rent/cost won’t tell you what your actual cash flow will be. But when comparing like properties in similar areas, rent/cost is a very helpful tool.

According to Gary Keller in The Millionaire Real Estate Investor, the national average rent/cost is 0.7 percent. For cash flow properties, you definitely want to be above one percent. We usually aim for around 1.5 percent, depending on the area.

Gross Yield

Used: For large portfolios

Annual rent / total price of property

Example:

  • Annual rent: $9,000
  • Total price (purchase and rehab): $100,000

$9,000 / $100,000 = .09, or a nine percent gross yield

This is basically the same calculation as above, but flipped around. It’s used more often when valuing large portfolios, but overall, it serves the same purpose as rent/cost.

It’s simple to calculate gross yield, which makes it a great back-of-the-napkin number. However, it leaves out so many variables, such as expenses and debt. It should only be seen as a shorthand tool and not an in-depth analysis.

Debt Service Coverage Ratio

Used: For obtaining financing

Net operating income / debt service

Example:

  • NOI: $25,000
  • Annual debt service: $20,000

$25,000 / $20,000 = 1.25 debt service ratio

Banks always want to see this important number, making it critical for obtaining financing. Generally, a bank will look at both the property's debt service ratio and your "global" debt service ratio—that of your entire company or portfolio. In regular English, debt service ratio is a metric used to determine if you can afford to pay off your loans.

This metric matters because nine times out of 10, when you’re buying real estate, you use debt.

A debt service ratio below 1 indicates that you will lose money each month. Banks don’t like that—and you shouldn’t, either. Generally, banks want to see a 1.2 or higher ratio. That provides a little cushion to afford the payments in case things get worse.

Learn more: Debt Service Coverage Ratio (DSC) – What it is and Why it Matters For You!

Cash-on-Cash Return

Used: For buy and hold investors

Cash flow / cash in deal

Example:

  • Yearly cash flow (NOI – debt service): $10,000
  • Cash into deal: $40,000

$10,000 / $40,000 = .25 or 25% cash-on-cash

Cash-on-cash return is also simple to calculate and tells you what your return will be in the first year of holding the property. This is a great calculation for investors who are intent on holding a property. It also helps you decide whether to use leverage—and what kind of leverage—as you can easily calculate how your cash-on-cash return will change if you reduce your cash invested by adding debt, which also increases the accompanying debt service.

In the end, cash-on-cash is the most important number: It indicates whether or not financing a cash investment is a good idea. In other words, cash-on-cash return computes the rate of return on an investment property on the basis of the cash invested in it.

Let's look at the above example. If you had $40,000 in the deal and made $10,000 that year, your cash-on-cash return is 25 percent. This is a critical calculation not only when it comes to valuing a property, but also when it comes to evaluating what kind of debt or equity structure to use when purchasing it.

Learn more: How to Calculate Cash-on-Cash Return (Made Easy!)

The 50 Percent Rule

Used for: Estimating property expenses

Operating income x 0.5 = probable operating expenses

Example:

  • Operating income: $100,000

Operating expenses = $100,000 * 0.5 = $50,000

This is a shorthand rule used to estimate property expenses. Whenever possible, use real numbers—i.e., the operating statement—but either way, this rule will help you filter out deals that don’t make sense. Just remember, a nicer building will have a lower ratio of expenses to income than a worse one. Plus, other factors, like who pays the utilities, comes into play. Don’t simply rely on this rule.

Related: The 50% Rule: How to Quickly Analyze a Multifamily Investment Property

The 70 Percent Rule

Used for: Determining an offer price

Offer price = (0.7 x after repair value) – rehab

Example:

  • After repair value: $150,000
  • Rehab: $25,000

Offer price = (0.7 x $150,000) – $25,000 = $80,000

Personally, I think this rule beats the 50 percent rule. The 70 percent rule helps you decide on an appropriate offer price. (And remember: You should never just offer the asking price, or even the market value of the property, per se. You should offer what suits your investing methods.) Always crunch the numbers down to the closing costs before actually purchasing a property. Any offer based off the 70 percent rule should be just fine—as long as your rehab estimate and after repair value estimates are correct.

Learn more: The 70% Rule: One Critical Formula Investors Need to Know

Equity Multiple

Used for: Understanding lifetime returns

Total cash distributions / total equity invested

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Example:

  • Total cash distributions: $273,000
  • Total equity invested: $150,000

$273,000 / $150,000 = 1.82 equity multiple ratio

The equity multiple (EM) ratio helps understand total cash return over the life of an investment. This is also an income and equity metric.

The EM differs from the IRR in that it does not take into account the length of the investment period or the time value of money. Because it does not factor in discount to present value and does not take risks or other variables into account, EM should not be looked at in isolation. Paired with IRR, however, you have a powerful combination of metrics.

The EM is a static factor, meaning it will not deviate year to year based on income or expense fluctuations.

Using Calculations for Real Estate Investment Property Analysis

The most important thing to remember when running these calculations is simple: One number does not a decision make. Real estate investment analysis requires a whole suite of metrics and calculations—because every one of these numbers tells you something different. Solid positive cash flow alone doesn't make a property worth buying.

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Andrew Syrios has been investing in real estate for over a decade and is a partner with Stewardship Investments, LLC along with his brother Phillip ...
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    Karla Barbacena
    Replied over 1 year ago
    I love computing ratios! Thank you – now these percentages make more sense to me now especially when it comes to financing and business offer side.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied over 1 year ago
    You might also want to check this article out for some more advanced calculations: https://www.biggerpockets.com/renewsblog/a-guide-to-internal-rate-of-return-and-other-financial-metrics/
    Tiffany Roberts from Eastern Michigan
    Replied over 1 year ago
    Awesome article, thanks for breaking all of these down. As a newer investor all the equations are a little intimidating and this makes them very easy to understand.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied over 1 year ago
    Absolutely Tiffany. Thank you. And while they can be intimidating, the calculations really aren’t that hard once you get the hang of them.
    Kevin McGuire Rental Property Investor from Seattle, WA
    Replied over 1 year ago
    Super helpful to have these all in one spot and great that you put their interpretation in context. Thanks for the (re)post! What is a good metric for evaluating a straight land purchase? (i.e. when there’s no income). I ask because I’ve considered rental properties where the cashflow isn’t great but it’s sitting on a good size lot. I was familiar with Cap rate and CoC but wasn’t clear on how to evaluate such an investment, I just don’t know how to model it. I figure if I understood how to evaluate a pure land purchase then I could weight a house purchase with land as say “50% rental, 50% land”. The Cap rate will be poor as an income property but the investment would be for appreciation of the land with some cash flow to offset the additional financing cost. This say versus a townhouse with a good Cap rate but less land and less appreciation, which is what I’ve bought so far. Thanks in advance!
    Roderick Mills Jr. from Cincinnati, OH
    Replied over 1 year ago
    Great article. Simple but to the point with good examples!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied over 1 year ago
    Thank you Roderick!
    Ryan Harris
    Replied over 1 year ago
    Gret Article!
    Alfredo Vera
    Replied over 1 year ago
    Hello all. I am new to the forums and I would like to thank Andrew everyone for their very valuable articles and forum discussions. I read this article and though I have been using some of the numbers mentioned here, I did not have specific targets (only aim high for the returns). On the cash on cash side, the discussions and article mention 15 or 20%, with no specific goal on that number. Is there a specific number which will deter you from getting into a deal? What is the minimum that would still make a deal a good one? Thanks very much in advance!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 8 months ago
    Thank you Alfredo. Unfortunately, with cash on cash return, it depends on several things; how aggressively we're financing it (75%, 100%, etc.) how nice the area is and how hot the market is overall. Usually, I want 15% or better at the minimum.
    King Chee from Los Angeles, CA
    Replied 9 months ago
    Great information! Thanks Andrew!
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 7 months ago
    Sure thing King, thanks!
    Sebastian Ekstam
    Replied 9 months ago
    U did an amazing job in sunmarizing this. Super good and important article
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 8 months ago
    Thank you Sebastian, glad you found it helpful!
    Nicole F.
    Replied 8 months ago
    Isn't the 50% rule actually calculated on gross rent, not operating income? Or is operating income just another term for gross rent in this case? When I see "operating income" I think of something that is already net of expenses.
    Andrew Syrios Residential Real Estate Investor from Kansas City, MO
    Replied 8 months ago
    Operating Income and Gross Rent are pretty similar. Gross Rent is usually the amount of rent stipulated in the lease (or what the property will rent for 100% occupied). Operating Income is all income you actually made. Usually it's calculated like this: Gross Rent (minus) Vacancy (and Delinquency) (minus) Concessions (plus) Other Income (i.e. laundry) = Operating Income