15 Most Important Real Estate Metrics For Investors

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Investing in real estate can be a profitable venture when you do it right. But how do you know you’re doing it right? That’s the question most investors have. Sure, you could buy the fanciest house in town and always have it filled with tenants, but how do you know that you’re charging the right rent, keeping your expenses at a manageable level, and handling the process well overall?

It all comes down to the real estate metrics for investors. Don’t worry; it’s not complicated math, but these formulas will help you understand if you’re on the right path. If you’re entirely unsure of where to start, check out Roofstock Marketplace and let the experts help you choose the right property using their metrics.

Debt-to-Income Ratio

If you apply for a mortgage to buy your investment properties, your lender will care about your debt-to-income ratio. You should care, too, since it’s a measure of how much of your income is committed to your debts each month.

If your DTI is too high, it’s hard to stay afloat or make a profit. It would be best if you kept your DTI within a reasonable level, so you always have money available in case of an emergency. Say, for example, you spend over 50% of your income on bills and the rest on the daily cost of living. What happens when your rental property needs emergency repairs? How will you pay for them?

Before you know it, you’ll have yourself further in debt because you’ll have to charge the repairs. 

Loan-to-Value Ratio

The loan-to-value ratio is another important metric of your investment property. This is another number lenders care about a lot, but you should consider it too.

Your LTV is a comparison of your loan amount to the property value. The higher your LTV is, the less money you invested in the property. Not only that but the higher your LTV, the higher your interest rate and fees on the loan. It may also be more challenging to secure financing if you don’t have great credit.

Your LTV should also concern you. A high LTV can mean a low or negative cash flow, which obviously isn’t the point when you’re investing in real estate. When you use Roofstock Marketplace, they’ll help you determine a property’s LTV to decide if it’s a good investment for you. 

Cash Flow

Speaking of cash flow, it’s the bread and butter of anyone’s real estate investment business. Cash flow is what’s left after you collect rent and pay the mortgage, taxes, insurance, and maintenance fees out of it.

Without cash flow, you don’t have a business. If you don’t have money flowing, first, you can’t afford to cover the maintenance and emergency repairs. But you also won’t have earned income from the property.

Not every property creates a positive cash flow year-round; some will have vacancies or unexpected expenses that make negative cash flow. But, over a year, you should average positive cash flow, or you may want to rethink your investment.

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Net Operating Income

Your net income is your gross income minus your operating expenses. Note, your mortgage payment isn’t an operating expense, so don’t include it in this calculation.

Operating expenses are all expenses you incur to operate the business. It could be service fees paid for contractors or other services performed on the house, fees to manage or maintain the property, legal fees, accountant fees, or any other fees you pay to help you with the property.

Net operating income helps you determine if a rental property is worth it. Is there enough rent in it to come out ahead after considering all the necessary expenses to run the property?

Capitalization Rate

The cap rate determines your return on investment. It considers the ratio between the income the property produces and the total property cost. The percentage tells you how much of the property’s investment will be profitable.

When you buy a property, the sales price is the property cost. When you own the property and want to calculate your cap rate, your cost basis is the property’s current value which you may need to get from a real estate agent or appraiser.

A higher cap rate means higher returns and higher risk, and vice versa. You can use the cap rate to decide what you’re comfortable with when investing in real estate.

You calculate the cap rate with this formula:

Annual operating expenses/Property cost (or value) = cap rate

Gross Rental Yield

If you’re trying to choose between multiple rental properties, look at the gross rental yield. This compares the gross rent to the property cost. Ideally, you want a gross rental yield of 7 to 10 percent.

If you’re comparing properties, you can compare them directly by looking at their gross rental yield percentages. The property with a higher gross rental yield will provide higher profits in the long run.

Make sure when you calculate this number, you use gross annual rent. Take the monthly rent and multiply it by 12 to get the correct number. 

If you’re just trying to decide if a particular property is a good investment, look for a gross rental yield of around 10 percent for best results.

Here’s the formula:

Gross annual rent/Property cost = Gross rental yield

Price-to-Rent Ratio

If you’re trying to decide if you should rent in a specific area or if you’re trying to decide if now’s the time to buy, look at the price-to-rent ratio.

This compares the area’s median home price to the median rent for the area. Ideally, you want an answer of 15 or less. If it’s higher, now’s not the time to buy at least in that area. If it’s less than 15, it’s a great time to buy, and you’ll likely have a decent return on your investment.

If you aren’t sure where to get this information, check out Roofstock Marketplace - it offers the numbers investors need to calculate their metrics and make decisions.

Cash-on-Cash Return

Cash-on-cash return helps you see how your investment is performing and if your ROI is on target with what you hoped. It’s a great way to tell if real estate investing is right for you or if you’d be better off investing elsewhere.

Your cash-on-cash return tells you how your investment is performing right now - not a projected return or annual, but this point in time.

To figure out your cash-on-cash return determine your property’s annual net cash flow and divide it by your investment. If you put down $50,000, that’s your initial investment. 

Let’s say, for example, you’re earning $10,000 a year in cash flow, and your investment was $50,000, your cash-on-cash return would be 20%. Compare that to other investment options, and you’d see that you’re doing well. But if you had a $2,000 annual cash flow and $50,000 down payment, your cash-on-cash return would be 4% and may not be the best use of your money.

Economic Vacancy

As a landlord, the last thing you want to think about is a vacancy, but it’s a part of doing business. In fact, if you have 100% occupancy, you’ll probably have a low cash-on-cash return because you’re likely charging below-average rents.

Instead, find out the average economic vacancy in the area and meet it. If you increase your rents, you’ll likely have more vacancies, but that’s ok. Look at the other numbers to see how you’re doing, including your cash-on-cash return and your cash flow.

1% Rule

The 1% Rule helps you understand if you should invest in a property. The idea is that you should be able to charge 1% of the property’s price in rent. If you do, you should have a positive cash flow. If you can’t charge 1% of the property’s price because it’s too high, then it may not be the best investment.

For example, if you buy a property for $200,000, you should be able to charge $2,000 in rent. If, after doing some research, you find that $2,000 is not within the normal range for the area, it’s not the best investment.

The 1% rule also helps you gauge where your mortgage payment should be if you need financing and how much room you have for other expenses so that you still walk away with a profit.

Return on Investment

Determining your return on investment is like looking at your past decisions, but it also helps form your future investments too. If your ROI is lower than you hoped, it can help you make decisions moving forward.

Should you charge higher rent, lower your expenses, or sell the property? Is it a bad investment, or did you just have a bad year? Use the number to guide you to future decisions so you don’t make the same mistake again.

Your ROI is calculated as follows:

(Gain - investment)/Investment = ROI

Debt Service Coverage Ratio

Your debt service coverage ratio is a figure banks will want if you try to get financing. The lower your DSCR, the higher risk you are and the less likely banks are to lend to you. If your DSCR is below 1, you’ll likely lose money and should not invest in the property. If it’s 1.2 or higher, though, it could be a good investment.

Here’s how to calculate it:

Net operating income/Annual debt service = DSCR

*Annual debt service is the annual cost of the financing to buy the property.

The 50 Percent Rule

This rule is a basic rule of thumb to give you something to think about before investing in a home. It states that 50% of your operating income will be expenses. You can then compare what’s left to see if it’s worth investing in the property.

Many factors play a role in this ratio, including if tenants pay some of the expenses, but it’s a quick way to see if a property is worth looking into or if it’s much too expensive and not worth your time.

70% Rule

If you don’t know how much to offer on a property, use the 70% rule. You’ll need a little information before you can use this rule, but it’s worth it in the end. First, find out what’s wrong with the home and what it needs to fix it up. Then get with an appraiser to figure out the after repaired value.

With this number, you can figure out your 70% rule.

0.70 x after repaired value - the cost of rehab = Target offer price

This isn’t a set-in-stone price, but it’s an excellent place to start with your offer. This way, you’re not offering the full asking price or even the full value of the home - you’re offering the amount that will leave you with the best ROI.

Depreciation

Depreciation is a real estate investor’s right-hand man at tax time. It’s a write-off real estate investors can take automatically. All investors can depreciate property over 27.5 years. You can’t include the land in the value, only the property, since land doesn’t depreciate.

For example, if your property is worth $200,000, you can write off $7,272 per year from your taxes. You can use this in your calculations as you determine if a property is worth it.

The Bottom Line

Choose the metrics that speak to you - as real estate investing isn’t a one-size-fits-all approach. You may want to focus on profits while another investor wants to focus on expenses. Choose what means the most to you and use the metrics to help you choose the suitable investments.

For more information, visit Roofstock.com.

Image Sourced from Pixabay

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Posted In: Real EstatePartner ContentRoofstock
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