As a real estate investor, it’s important to track your progress and performance by measuring key metrics. These metrics will help you make informed decisions about your business and ensure that you’re on the right track. You cannot forecast from pure instinct, you need to plug your numbers into some formulas to see some real numbers. In this blog post, we will discuss the most important metrics that you should be tracking. The first four are related to properties that you hold (Cash Flow, Cash on Cash Return, Net Operating Income, Cap Rate) and the last one is related to the overall function of your business (Cost Per Lead / Cost Per Contract).
Let’s start with the most fundamental investment metric, Cash Flow. It essentially tells you how well your business is or isn’t doing in a dollar amount. Cash Flow measures the amount of cash that is coming in and out of your property or business as a whole.
To calculate this on a property level, you will need to take into account all of the revenue streams generated by your property (rent, laundry, parking, etc.), as well as all of the regular expenses associated with it (mortgage payments, taxes, insurance, repairs & maintenance, etc.).
Cash Flow really matters because it takes into account every other general metric: income, expenses, net operating income, and debt. The orchestra of these variables results in your monthly income in real dollars, so you need to understand the mechanics to create healthy Cash Flow. For example, if you’re renting a building for $10,000 per month and your total costs and debt are $7,000 for that month, your net cash flow is $3,000 at the end of the month.
A negative cash flow is not good; reasons for a negative Cash Flow could be that your debt payment is too high, your expenses are too high, or your income is underperforming for some reason. Calculating this is essential before you jump into an investment, and monitoring it over time will help to understand if we are hitting the right benchmarks.
Net Operating Income (NOI)
NOI = Gross Operating Income – Operating Expenses
Net Operating Income (NOI) is different from Cash Flow as it does not take into account debt service, or how much of the income is retained as profit.
Net Operating Income is the Gross Rent for the period minus the operating expenses. The most common operating expenses are the following:
- Management (This should normally range between 8-10% of Gross Income)
- Maintenance (we often assume that this will be in the range of 10% of income)
- Taxes (This value is a matter of public record, and can be researched on the counties tax site in most areas)
- Insurance (This number should be provided by your insurance agent)
- Vacancy (A good rule of thumb is 8% as that is generally about 1/12 or would account for one month of vacancy a year.)
- Other expenses may include, utilities, trash, landscaping, or other common area expenses
Don’t forget to include any service fees that are generating income for your property, such as storage or laundry machine fees. Also, be sure to account for any expenses that you may have to put back into the property for repairs or maintenance.
For example: If a rental property generates $87,000 in rental income per year and has $42,000 in annual operating expenses, the NOI would be $87,000 – $42,000 = $45w,000.
To restate, a property’s NOI is the amount of capital remaining for debt payments and Cash Flow after all operating expenses have been paid.
Cap Rate = Net Operating Income Value
Cap rate (Capitalization Rate) is essentially the same thing as Return on Investment, known from traditional investing, like in the stock market.
Cap Rate indicates the rate of return that is expected to be generated on a real estate investment property if the property was purchased in cash and had no debt expenses. We can see that Cap Rate is the ratio of a property’s Net Operating Income to its original purchase price, thus, it gives you the percentage of the investment’s value, which is the profit.
Most often Cap Rate is used to help reach valuations on income-producing properties.
For Example: if similar properties to your target property have sold at an “8 Cap” this means that they have sold at a valuation that would suggest a Cap Rate of 8%
If your property is producing an NOI (as shown above) of $45,000 then we know that in a market where similar properties have sold at an 8 Cap, this property should be valued at around $562,500 ($45,000 / .08 = $562,500)
Another application of this would be the same property was sold for $450,000, would infer a Cap Rate of 10% ($45,000/ $450,000 = .10). This would suggest that the investor may be able to achieve an above-market return. This can happen for a number of reasons but may suggest that there is some type of additional risk that may be present in the property.
Cash on Cash Return (CCR)
CCR= Annual Before Tax Cash FlowTotal Cash invested
Now you might be wondering what’s the difference between CCR and the Cash Flow. First of all, the main difference is the way each one is expressed: CCR is a percentage of income, and Cash Flow is income in dollars (or in whichever currency you’re calculating it). And secondly, CCR suggests the return you’re getting from the total amount of money you have invested into your property; whereas Cash Flow indicates how much cash you are receiving month over month after all expenses are paid.
The CCR refers to the rate of return on a real estate investment and it’s calculated by dividing gross cash flow over the total equity invested. The total equity invested refers to the sum of your repairs, expenses, down payment, closing costs, etc., but not the amount you are borrowing for a loan. In other words: what percentage of my capital am I making back every single year in profit from the Cash Flow?
Cash on Cash Return and Cash Flow often work together, but don’t let the numbers fool you. You might be generating cash flow monthly from one of your investment properties; however, this is where CCR comes into the picture and dictates your return based on monies invested.
Just think about it: you have a property that generates $500 cash flow each month, but it costs you $300,000 to buy. That’s approximately 2% CCR on an annual basis, Whereas, another property might be generating $350 cashflow but you may have only purchased it for $60,000. In this case, the CCR is 7%. So in this way you can better understand the actual return that is being seen in the amounts invested.
This metric is very helpful to assess the best way to finance a new investment project, choose between potential investments, and forecast the returns by taking your initial cash invested into consideration.
Cost Per Lead / Cost Per Contract / Cost Per Closed Contract
While working through a real estate business it is very important to track marketing expenses. One of the most effective ways to track this is through three parallel metrics. Cost per Lead, Cost per Contract, and Cost per Closed Contract.
Cost Per Lead is tracked by calculating what it costs in a given period to attract all of the qualified leads into the business. So if the firm spent $15,000 on leads, and was able to generate 7 leads, the cost per lead would be $2,143 per lead.
Cost per contact for the same period would consider how many of those 7 leads (and any existing leads) converted to a contract. So if 3 Contracts were completed, the cost per contract would be $5,000.
The final Cost per Closed Contract, takes into account that some properties don’t make it through the due diligence process for one reason or another. Therefore we want to know how productive the marketing dollars are that we are spending. If once the contract falls out given the 3 contracts listed above, and we end up only closing 2 of them, our Cost per Closed Contract would be $7,500 for that period.
Now that you know the most important metrics for real estate investors to track, you can start using them to analyze your performance and make better investment decisions. Just remember that every investment is different, so there is no one-size-fits-all approach. The key is to understand what each metric means and how it can be applied to your specific situation.
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