Want to Be a RE Millionaire? Here Are 5 Metrics You MUST Master

by | BiggerPockets.com

Who wants to be millionaire? Well, everybody! (Obviously!) Becoming one doesn’t require rocket science, either. It’s pretty freakin’ simple. 

Notice I didn’t say easy, but simple.

As most of this awesome community knows, one of the fastest ways to building a million-dollar net worth is through income-producing real estate. The beauty of income-producing real estate is that it’s an asset class where you can basically print money.

If you are able to either increase income or lower expenses, boom, the value of your asset goes up in accordance with how much you increase profitability.

The beauty of income-producing real estate — cash flow, value appreciation, capital events — have been repeated ad nauseam on these pages, so no need to get into that too much right now.

(SIDE NOTE: It is actually for that very reason that I don’t like stocks — too many variables outside my control. Because of the blood in the streets on Wall Street, I bought into some tech stocks (AI/VR, Snap, Twitter, Square, BlackBerry and a few others), figuring I’d made money on the buy (I did; on literally all of them) — and I absolutely hated it. I’m working on a piece about that horrific, very profitable experience. Watch out for that.)

However, like in anything in life, you won’t make it far unless you know your basic numbers. And real estate is no different. And it’s not just about the numbers themselves, but the meaning behind the number.

Context

So, I’ve written in the past about how you can — in theory — turn $500 into a $1 million asset in less than two years with basic math. It’s totally doable. But in order to do so, you’ve gotta know your numbers — and the metrics.

Here are 5 Vital Metrics You Must Master to Succeed in Real Estate

1. Cap Rate (with context)

The basic definition of a cap rate is the hypothetical yield on a property, assuming it was bought cash. (Read this BP piece for more detail.)

Here’s the equation:

Obviously, nothing is ever really set in stone. Shit happens (this is why you account for vacancy, for instance) so this figure invariably varies.

However, it is a crucial starting point for any investor to determine whether an investment is feasible.

“Philip, what’s a good cap rate?”

I get asked this all the time, and there’s no straightforward answer. It depends on asset class, the state of the building, market, etc. #Context.

But in short jargonese, the lower the number, the lower your yield. (Obviously you want a higher number; if not, what’s the point? Throw your money in a municipal bond instead, sit on your ass, and collect the tax-free yield.)

The higher the number, the higher the yield. Pretty simple.

But here’s the trick with that. Big-city markets typically have lower cap rates because they’re deemed safer investments, and value traditionally curves upwards. Smaller markets typically deliver higher yields because they’re considered higher risk investments.

Anyway, we can discuss cap rates ’til the cows come home. However, this is often the first question you ask your broker when he sends you a deal. “What’s the cap rate?”

And you go from there. So understand this figure: Your net income divided by the price in a percentage.

Related: How to Get Rich: 7 Awesome Ways to Build Wealth Today

2. NOI

Read this one carefully because this one may be the most important to master. In boxing they say everything comes from the jab; it’s not the knockout punch, but it sets everything up for the big win.

Net operating income (NOI)—real estate’s equivalent to corporate finance’s EBIT — is defined as your gross income minus expenses.

In layman’s terms, this metric is your money maker, your profits, your extra cheddar. So forget all the noise. If you’re already in a deal and investing for both extra cash and net-worth boosts, this is the metric that matters.

The cool thing about real estate is that — beyond rent, which should obviously account for 95+ percent of your asset’s income —there are only so many ways you can generate revenue, none of which should distract you from the main source…which is rent!

And here’s the kicker: the value of your asset is derived directly from the income it produces. Not supply and demand, not the S&P, not the economy, but from how much money you can manage to squeeze from it.

In other words, if you can figure out how to increase your NOI, you’re well on your way to building your fortune.

3. OPEX

Operating expenses. Credit: AX.

Whether you’re an owner or potential buyer, a property’s operating expenses (OPEX) is a basic but extremely important metric to monitor — and very often the hack for value-add investors to unlock crazy profits.

As the name suggests, OPEX is essentially what it costs you to run the property, which includes trash removal, taxes, management fees, maintenance, and so on.

As an owner, the metric is vital for no other reason than if you’re mismanaging your expenses, you’re eating into your profits and thus the value of your asset. As a potential buyer, mismanagement could mean big money for you.

In last week’s article (Newbie Landlords: This Might Be The Most Important Metric To Know), I told the hypothetical story about Uncle Bill and his 25-unit apartment building that was bleeding money due to delinquent tenants and unfavorable tenant laws. In the piece, I illustrated how you can force the appreciation by running the numbers.

Operating expenses. (Credit: AX.)

As illustrated in the story, you raise some money, buy out Uncle Bill — he’s cashed out with a million dollars, sipping Margaritas on a beach somewhere. And you’re sitting pretty on a $2+million asset. Here are the basic assumptions for how that comes to be:

  • 55 percent current OPEX
  • 9 percent cap rate for the market
  • You buy it for $1.4 million at an 8 percent cap rate
  • You cut OPEX to 35 percent
  • Raise rents 15 percent

Even though you overpaid for it, by getting OPEX (and NOI) under control, you’re sitting pretty on a $2+million building:

                                             $287,500 NOI minus 35% OPEX divided by 9% cap rate = $2,07,388.89 

How about it, eh?

4. DSCR: Can You Pay The Bills?

The DSCR metric sounds offensive for no real reason: “Debt service coverage ratio.”

That aside, it’s actually pretty sensical once you get to know it — and super important to know. In regular English, DSCR’s a metric used for banks and lenders to determine if you can afford to pay off your loans.

This metric matters mainly because nine times out of 10, when you’re buying real estate, you’re going to use debt to complete the buy anyway. Gotta know how to leverage.

Anyway, here’s the formula: NOI/annual debt (“total debt service”).

And here’s a somewhat-informative video breaking it down in jargon, but the visuals are pretty cool.

A ratio of one puts you at breakeven — meaning there’s just enough to cover your interest payments. Banks won’t go for that; they want you to have a cushion just in case shit happens. (Fannie Mae and Freddie Mac want you at 1.2x for multifamily loans.)

Even more importantly, what’s left over after debt service is your free cash flow — your pocket money after the bank’s gotten its piece. If you’re a cash flow investor, this is a serious one to monitor.

NOTE: While the calculation itself is relatively straightforward, getting an accurate figure can be tricky. Lenders might fiddle with your NOI assumptions—which could lower the DSCR even more — before granting the loan. So make sure your spreadsheets account for the different variables. (Shoot me a DM if you’re just starting out and want one.)

RelatedHow to Become a Millionaire: The Ultimate Guide

5. ROI

Return on investment. Internal rate of return. Return on equity. Cash-on-cash returns. There are many ways to measure the profitability of a real estate investment.

For the sake of this point, I’ll simply use the generic umbrella return on investment here since the actual metric may vary based on your strategy.

Jargon and technicality aside, at the end of the day, before you go into any deal, you always want to know what your returns are going to be. Here’s a pretty informative discussion from the BP forum.

For most, however, the simplest and quickest way to calculate your returns — especially when starting out — is to look at the return on capital invested; money-in, money-out. Which is the cash-on-cash ROI metric. 

Here’s the formula: cash flow divided by cash invested.

It’s quick and dirty, fairly accurate, and allows you to contrast and compare to other investment vehicles like stocks, bonds, and so on.

Say you have a $1.5 million apartment building with $50,000 in annual cash flow that you bought at a 80 percent LTV (meaning 20 percent down). That’s $300,000 down invested in the down payment:

$50,000/$300,000 = 16.67%.

Again, this is just one of several relevant return metrics and obviously doesn’t apply to value appreciation, a core strategy for many investors. But if you’re looking to compound wealth and generate passive income, this is a great one to start.

Any other metrics new investors should know?

Let us know in comments below! 

About Author

Philip Michael

Philip Michael is a real estate developer, entrepreneur, investor, and author of How To 10x Your Net Worth In 18 Months. He’s the founder of NYEG, former on-air host on SiriusXM and NuvoTV, and former national editor/content strategy director at Bisnow leading up to the company’s $50M sale. Follow Philip on Twitter at @Philip_Michael or @yfwtb on Instagram. Real estate investment analyzer HERE: gum.co/AXdeluxe

17 Comments

  1. Ali Hashemi

    I enjoy reading your posts it’s a shame you’re using them to make money for yourself.

    Your other article you were selling software.

    This post you’re selling referrals to investing site Robinhood. You get rewarded for referrals.

    Hopefully the moderators put an end to your concealed solicitations.

    • Philip Michael
      Philip Michael on

      Hey Ali,

      Thanks for reading. I’m not “selling” anything. It’s a free stock (i.e. free money) for everyone who downloads a FREE APP, including myself. I’d encourage anyone who downloads it to share it with their circle and get more FREE MONEY.

      That’s not solicitation or selling, that’s a hookup, bro. I don’t work for Robinhood — I don’t even like stocks. (Watch out for an upcoming post about that.) But it’s FREE MONEY.

      Hope you found the information useful otherwise. Thanks for reading and commenting. Cheers, Phil

    • Ali Mahvan

      There can only be one Ali. Hahaha. I don’t know. This is a pretty lengthy and detailed article to be referred to as a “sales pitch” for a quick plug in parentheses and italics in the intro.

      Don’t forget, journalists have to eat too. If he can eat by dropping a quick plug instead of charging me for a monthly subscription or killing me with ads, I’m all for it.

      That said, I’m a little confused on the 16% of $50k/$300k for the last paragraph. I’m new to real estate, and cashflow is king in the business I come from. Why would I divided my annual return over my initial investment?

      Phil, could you explain this in a little more detail?

      • Philip Michael

        Hey champ. Nice to see you on here and thanks for reading.

        In spite of what you may think, I actually don’t eat off this; I don’t get paid to write these articles (though I could for other platforms). I do it because I love BP and get to interact with other young investors (which I enjoy).

        Also, this is a platform teaching people how to accumulate wealth. Everyone who clicks that makes money for downloading the app. It is literally FREE money. And you get to start investing. There’s no sale, no cost. Just free money! It’s almost absurd. You basically made money for reading my sh*t. #freemoney

        As for your question, it’s one of the metrics for profitability you use in real estate. In this case, if you were to compare it to a bond. Money in, yield out.

        I personally invest for equity appreciation more so than cash flow. Wrote an article last week, I believe, where I broke down expenses and how it impacts value. (Should be linked in article.)

        And despite what Marvin mentioned in another comment, there actually is a story about a guy who never made more than $14k a year, but invested what he could and compounded his investments into a retirement balance of $70 million. https://www.entrepreneur.com/article/240206

    • Eric Washington

      Huh? Was he selling something? I honestly had to go back and check. I was content checking the post before I shared with it with my investment partners to make sure they keep focused on the key elements of investing in CRE. Anyway, if he was selling something it was a “soft sell” and I’m OK with that. The more people that know how to run the numbers, the better chances I have of getting a good deal from a Wholesaler, or getting a lead on a good deal from somebody that actually knows what a good deal looks like. Unfortunately, Wholesalers are pitching Proforma numbers as deals or marking up active listings by Brokers. This was a great post to set the record straight. A true investor will run these numbers and every Wholesaler SHOULD know how to run these numbers, Please!!!

  2. You can turn $500 into 1 million in assets in 24 months using metrics. What an eye-catching headline. That’s about as easy as turning 500 lemons into an apple pie. You need a lot more than metrics to be a successful, lifelong real estate investor.

  3. Tim Sabo

    Once again, Philip makes-what seems like economic mumbo-jumbo to most of us-into common sense language that BP folks can use to grow wealth. True, no one gets wealthy off of metrics: if that were the case, statisticians would all be fabulously wealthy. Metrics, like the hard work that follows, CAN PROVIDE A PATH to the Yellow Brick Road (or Golden Brick Road, if you will), but they can not get you there alone. Numbers, even if you DO know how to crunch them correctly, makes no one wealthy: it is the determined application of knowledge combined with a disciplined approach to hard work that points the way to the Emerald City.

    Philip-thank you for sharing your knowledge with us: I am a little bit wiser with each article.

    • Philip Michael

      Thank you so much, Tim! I’m glad you find my stuff helpful. I put a lot of time and effort into it so it makes me happy when people enjoy it. And great, great point also re: hard work and determination. SO TRUE! Thanks again!

  4. Dave Rav

    Great article! I liked how you broke down the calculations. Some of this I already knew, some i didn’t.

    For Cap Rate, can you use ACTUAL value of the property OR the purchase price? I was taught to use PP but your article just says “value” of the property?

    The most profound metric calc in your article was the reverse way to determine value using NOI, OPEX, and Cap rate. I never knew that. Its awesome and pretty accurate for determining value of a multi-fam prop where comps can be tough, and offers another way to present to buyers (than Cap Rate).

    TY!

    • Philip Michael

      Hey Dave! Thanks—glad you liked it!

      And yes, the cap rate has that dual purpose. You look at it to assess yield but also to determine value.

      With real estate, there are three appraisal methods; comparables (comps; used for single family), income capitalization (income-producing real estate) and replacement (what insurers use).

      So with the income capitalization method — Investopedia just calls it “income method” https://www.investopedia.com/terms/i/income-approach.asp — the value is derived from the income it generates. (Obviously cap rates are different, depending on market, building class etc.)

      This is why income-producing real estate vs. single-family is such a great investment overall; if you have the right CRE asset class, your downside is super protected against economic downturns — especially if you’re not too highly leveraged. (i.e. not using up all your equity to pop bottles in the club, invest in risky stuff or other shenanigans.)

      I personally shy away from office and retail, simply because I’m not bullish on it—traditional overhead is dying and that kills the feasibility. (Although WeWork and Airbnb inspired models can work.)

      But I’m super bullish on shelter. Just like I’m bullish on air. And water. Etc.

      That’s why OPEX management is such a great “hack.” In my pro forma for developments, I keep a conservative cap rate figure along with a cell that shows me the valuation. That gives me an instant idea of how many units to go for, where I can cut on the OPEX, what to rent for — and how much the asset overall ultimately is worth.

      Apologies for the lengthy answer, but it was a great question with a lot of dimensions to it. Hope that explains it a bit!

  5. John Murray

    Here is how an entrepreneur does wealth building math forget the metrics. Money in- Money out- Low burden= Reinvestment capital. Reinvestment Capital x Successes= Profit. Profit -Low tax burden= Wealth building. The key is low tax burden, pretty simple concept. If you can master these simple concepts you will become a multimillionaire like me.

  6. Jim Watson

    Yes these are the standard tools but there’a lot more to that successful apartment building. Finding a good deal in todays hyper competitive market. Raising the 300k down? You better know real estate investment to sell the idea to someone. No details on researching demographics, area companies, local vacancies, potential appreciation, etc, etc. There’s no mention how to fund big ticket items like roofs, boilers, water damage that can ruin a bigger investment. Sorry but it’s not as simple as this article makes it sound like.

  7. jake snake

    While these metrics are good, one huge win of real estate is the tax advantages. I recommend calculating the after-tax profits, since this will also take into account how well you are investing in your properties; for instance, if you are paying a large amount of taxes, it can be beneficial to re-invest profits into improving properties.

    Due to this, I also recommend calculating an ‘all-in’ value of the investment. This ‘all-in’ value should include:
    – income
    – expenses
    – depreciation
    – equity growth

    At the end of the day, a property that has negative cash flow could be appreciating much faster in equity (such as in a scenario where you’ve inherited a tenant paying below market or mortgage cost).

    It’s important to include all value factors here when valuing the investment.

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