Low-interest rates, an increase in foreclosures, and elevated price of rents across the country has led to an increase in the number of real estate investors. People have seen this as an opportunity to make a lot of money very quickly and are willing to put in the hours and the work, but many don't know how to track their property metrics.
Property Metrics in a Nutshell
In general, property metrics are the numbers that you take into consideration when evaluating past business and projecting for future business. These are often also known as key performance indicators, or KPIs.
There are two main buckets that metrics fall into, property evaluation and property financing. Evaluation is all the numbers you are using to calculate return on investment, expense, etc. Financing are all the numbers related to your loan terms, assuming you are not dealing only in cash.
There are many different pieces of analysis software or even apps that can help to calculate and track your metrics, but below are the basic calculations.
Property Evaluation Metrics
When considering the purchase of a property, there are specific numbers you should look at to determine if it is a sound investment. Below are the three most important:
- Gross Rental Yield: To find this number, divide the projected annual rental income by the total cost of the property and then multiply by 100. Ideally this number will be under 10. The lower the better.
- Capitalization Rate: Subtract the estimated annual operating expenses from your annual rental income and divide that by the total cost of the property, then multiply by 100. Unlike rental yield, you want this number to be higher than 10.
- Price to rent ratio: Divide the median home price of the area by the median annual rent. A recommended number here is anything under 15.
- Cash on Cash Return: This is the ratio of annual before-tax cash flow to the total amount of cash invested. This number helps to track and predict cash flow.
- Internal Rate of Return: This metric is used in capital budgeting to estimate the profitability of potential investments.
Property Financing Metrics
These metrics all pertain to the financing that you will secure to purchase an investment property. The same metrics are used for non-investors, but they are considered slightly differently.
- Down Payment: This is obviously the amount of money you are putting down on the home. Most investors need to put down 20-25%. It’s important to determine if you have the cash flow to afford this before considering a purchase.
- Debt-to-Income Ratio: This metric works in the favor of investors, as they are allowed a higher ratio. This is because investors can use the rental money as part of their “income” if they meet certain criteria.
- Loan-to-Value Ratio: To find this number you divide the mortgage amount by the purchase price and multiply by 100. The result should be between 80-95%.
Using Property Metrics to Drive Your Business
The easiest way to use metrics to drive your business is just to know what they are! Always be tracking your investments and being thoughtful about your next steps. Use these metrics to evaluate past progress and plan for the future.
The property evaluation metrics will guide you to make smart investments in properties that will likely have a high return, allowing you to invest in more properties. The market ebbs and flows, but if you have a good handle on your numbers, you should be able to manage it.