“6 Key Financial Metrics to Consider for Your Real Estate Investment Deals” is our ninth in a series of blog posts on real estate investing. To read more, download our entire eBook, “The Real Estate Investor’s Checklist.”
In general, real estate investing involves a lot of simple math. Understanding real estate ﬁnance includes knowing some of the key formulas and ratios. Here are some of the most common real estate formulas and metrics you should use to evaluate your investment deals.
Net Operating Income
Net operating income (NOI) is one of the key metrics of the financial analysis. It is the total income the property generates (after all expenses), not including debt service costs (loan costs).
Cash flow is the total profit you will see at the end of the year from the property. To determine the cash flow, simply subtract the total expenses from the total income. The higher your debt service payments (the larger your loan, the higher your interest rate, or the shorter your amortization period), the smaller your cash flow.
The capitalization rate (Cap Rate) is used determine what a property is worth. It takes into account vacancy, credit losses, other income, and operating expenses. Because the Cap Rate is independent of the buyer and the financing, it is the most pure indication of the return a property will generate.
Cash-on-cash (COC) return is directly related to the amount of cash you put down on the investment. It is the equivalent measure of how much return you would make for each dollar you put into the property.
Internal Rate of Return
Internal rate of return (IRR) for an investment is the percentage rate earned on each dollar invested for each period it is invested. IRR is also another term people use for interest or yield.
Net Present Value
Finally, net present value (NPV) is an investment measure that shows whether the investment is achieving a target yield at a given initial investment. It also quantifies the adjustment to the initial investment needed to achieve the target yield, assuming everything else remains the same.
Be on the lookout for our upcoming blog post covering the most costly real estate investing mistakes to avoid, or download our entire eBook, “The Real Estate Investor’s Checklist.”