When it comes to adding another rental property to your real estate portfolio, you need to think about more than just what the transaction will cost.
A lot of factors go into determining whether or not a particular piece of real estate is a good buy. That’s where metrics come into the picture. You will want to dig into the nitty-gritty to ensure that you’re getting a good deal.
So that you make the right real estate investment moves, here’s a look at real estate metrics that every investor should know and understand.
Net Operating Income Metrics
The net operating income (NOI) metric indicates how much a property investment can net you. This figure will help you figure out whether or not a particular property is a good investment for your purposes.
When you know the property’s revenue- and profit-generating potential, you’ll be able to determine if you’ll make enough to cover mortgage payments.
In order to tabulate your NOI, what you’ll need to do is figure out your total income and then subtract the operating expenses. When you’re performing this calculation, don’t include the mortgage payment amount.
Remember that mortgage payments, while obviously important, are not actually operating expenses. So don’t include these payments when figuring out the NOI. You’ll also want to leave out taxes and interest payments.
When you are considering operating expenses, include things like property taxes, legal expenses, property manager costs, and general maintenance fees.
When looking at important real estate metrics, you’ll also want to focus on the capitalization rate or cap rate. It shows your return on investment.
Basically, this metric demonstrates the ratio between how much income a property produces and the original capital invested into the property.
So what you’ll get when you calculate the cap rate is the percentage of your investment’s worth that constitutes the profit. It’s calculated by dividing the NOI by the asset worth.
You need to know the capitalization rate metric because the higher this figure is, the more risk you’ll be taking on. Different real estate investor types are comfortable taking on varying levels of risk. What is your risk tolerance?
You may very well be fine with taking on higher risks to potentially enjoy higher rewards. It may also be the case that you prefer to take on lower risks to reduce the odds of potentially jeopardizing your investment.
Operating Expense Ratio
The operating expense ratio (OER) quantifies profitability. Specifically, it determines how you’re fairing as per managing your expenses relative to how much you’re making.
You can determine the OER by tabulating operating expenses minus any depreciation and dividing the figure by the operating income.
You’ll want to be particularly close attention to OER because it will show you how well you’ve done at reducing costs relative to your revenue.
Lenders consider loan-to-value (LTV) when assessing the risk profiles of applications. A higher LTV is associated with a higher degree of risk.
If you go to a financial services entity or a private lender for a loan and it finds that your LTV is relatively high, you could be required to pay a higher interest rate and/or to make a bigger down payment.
Gross Operating Income
You’ll want to consider gross operating income (GOI) to figure out how much capital you’ll need to operate a property.
The GOI is the tally you come up with when excluding credit and vacancy losses from the gross potential income of a piece of real estate. This metric is also called effective gross income — and it’s a metric you need to know.
Gross Rent Multiplier
If you’re considering multiple real estate investment properties and want to figure out which one to make an offer for, then the gross rent multiplier (GRM) metric is critical. It offers a way to compare properties.
So when using the GRM, you’ll more easily be able to track down the most formidable properties to invest in. You can figure out the GRM by dividing the real estate asset’s price by its possible gross yearly income.
If a property is being sold for $1,000,000 and has a yearly income of $200,000, for instance, then the GRM for the property is 5. You’ll get the most out of this metric if you use it to compare similar real estate.
Internal Rate of Return
You can use the internal rate of return (IRR) metric to project the interest you’ll earn on the amount you invest in a rental property. It will give you a good idea as to a property’s ability to generate a specific rate of growth.
When you want to tabulate the IRR, you’ll need to assign a value of zero to the net present value of the property in question and then add projected cash flows for the number of years you want to hold onto the property.
IRR is a useful metric. But you should take note that it assumes that there won’t be any surprise repairs needed and that the rental environment will be stable without any hiccups. So this metric isn’t perfect by any means.
Do You Need a Private Lending Solution?
If you’re thinking about purchasing a property, you’ll want to know the aforementioned real estate investment metrics. Understanding them and knowing how to use them will help you make the right investments.
We have you’re covered if you’re looking for rental loans from a reputable private lender. Our objective is quite simple. We lend to investors who want competitive rates and a personalized lending experience.
Get in touch for a quote on a rental loan. You can also give us a call if you have any questions or if you’d like to apply for a real estate loan.