Rents and sales prices are only part of the picture when it comes to real estate investments.
A good management strategy requires knowledge of which indices are needed to closely observe (track). Real estate investors and managers can improve their overall performance by tracking these indices or metrics.
These metrics relate to income-producing properties (investment properties) such as commercial real estate and tenant-occupied residential properties.
The following metrics are vital for real estate appraisers and investors to be aware of in order to improve their financial performance.
Profit is the amount of money realised each cycle after income (rents and other revenue) has been collected, operating expenses have been paid, and a cash reserve has been set aside for future repairs. In other words, it tells you how well or badly a property investment is doing.
The cash flows from a real estate investment are forecasted over a specific holding period and can be divided into recurring and terminal flows.
In the case of property investment, positive cash flow means the income or revenue generated exceeds the maintenance costs. A property with a negative cash flow is one that has a higher maintenance cost than it generates in revenue. There may be a need to review the property’s expenses or to investigate how recalcitrant tenants are negatively impacting the bottom line of the property.
It is also known as the ‘Cap Rate’. One of the most important indexes for measuring the performance of investment properties is the capitalisation rate. An investor can use it to estimate the potential return on their investment. Similar properties in different markets are compared using cap rates in appraisal practice.
Calculated by dividing annual net operating income (NOI) by the property’s market value, Cap rates are used in commercial real estate valuation. A higher cap rate means a lower return on investment. Cap rates vary depending on whether annual rental income is gross or net of property operating costs
When the cap rate is high, the risk level is higher, indicating a higher return.
Net Operating Income (NOI)
Commercial real estate investments such as income-generating properties are evaluated using the Net Operating Income (NOI) metric. An investment property’s return on investment tells you how much money you make. Revenues (income) from the property are deducted from operating expenses to determine the NOI. Having parking facilities and laundry facilities may generate additional revenue (on top of rental income) for the property.
Operating expenses generally include management fees, legal fees, building maintenance, property taxes, insurance premiums, utilities, repair costs, and service fees.
You should not include mortgage payments or interest, capital expenditures, and taxes in your NOI calculation since these items are not considered operating expenses.
It is possible for projected rents to prove inaccurate when using NOI as a potential investment appraisal tool. When a building is not managed properly, income (rents) may be inconsistent. The NOI is a measure of a building’s ability to generate revenue and profit, which is used by investors and lenders to determine whether a particular investment can generate enough income to cover mortgage costs.
Loan to Value (LTV) Ratio
By comparing the loan amount to the value of the property to be used as collateral, Loan to Value Ratio is a tool for assessing the amount of risk a lender assumes when providing a loan to a borrower. Borrowers typically advance loans that are just below the collateral’s market value.
High LTV ratios indicate high mortgage risk. The LTV ratio of less than 80% is typically acceptable to conventional mortgage lenders. By comparing the loan amount requested to the pledged collateral, the LTV ratio is calculated. As a result, it is the most accurate way to calculate a property’s equity.
Lenders advance loans based on a percentage of property’s value, which determines how much cash you will need to put down.
Gross Rent Multiplier (GRM)
An investment property’s GRM helps appraisers and investors compare properties and estimate its value roughly.
Calculate the Gross Rent Multiplier by dividing the property’s market value by its gross rental income. According to your local market and comparable properties, you will be able to determine a “good” GRM.
One of the biggest disadvantages of the gross rent multiplier metric is its simplicity. A property with a low GRM is not necessarily a good investment. It is due to the fact that the metric does not take maintenance and operating costs into account.
Operating Expense Ratio (OER)
A property’s OER shows how efficient it is financially. It can be used by investors to determine if expenses are well controlled in comparison to revenues.
Divide all operating expenses, less depreciation, by operating income. A common ratio used by investors, it includes depreciation, so the property costs are more fully accounted for. OER should be between 60 and 80%.
When deciding between multiple property investment opportunities, a prudent investor should pay attention to higher maintenance and utility costs.
There is a ratio between the amount of space available and the amount of space that is occupied.
From the perspective of a real estate investor, occupancy ratios are good predictors of cash flow, and they permit comparison of property performance. The occupancy rate of a property is clearly important to investors. Occupancy ratios that are low may indicate that the property is in trouble.
It is inversely proportional to the occupancy ratio that the occupancy ratio is high.
Total Units Rented / Total Available Space = Occupancy Rate
When investors make decisions such as whether to buy or sell, real estate metrics guide them. Furthermore, they can be used as performance-tracking tools to identify potential and existing problems before irreversible damage is done.
Property investors and owners should consider them as part of their investment objectives, the market, and the nature of the property when making critical decisions.