The Key Metrics Every Investor NEEDS to Know
A real estate investment is only as strong as the investor’s understanding of the numbers. Without a solid foundation for calculating a rental property’s success potential, you could inadvertently expose yourself to potential financial loss. In this post, we will break down the key metrics that every real estate investor needs to know to crunch the numbers of a prospective deal like a seasoned professional.
Gross yield is the gross potential income divided by the investment price, converted into a percentage. This ratio does not factor in expenses and can vary from state to state due to variable costs such as property taxes and insurance. It is a good starting point for realizing how your property might perform.
Gross yield = annual gross income / cost of investment
To put it simply, cash flow is the money flowing in or out of your investment. This metric helps to determine if you can cover expenses and still turn a profit. It is sometimes referred to as net operating income.
Cash flow = gross income – operating expenses
Referred to as cap rate or capitalization rate in the world of commercial investors, this ratio converts the cash flow into a percentage as it relates to the cost of the property. The net yield, is your potential annual ROI (Return on Investment) for a rental property. This is a good calculation to compare multiple investments as apples to apples.
Net yield = annual net cash flow / cost of investment
Similar to cap rate and net yield, this calculation is often used to evaluate the cash flow from a rental property. This ratio takes into account leverage, or financing.
Cash-on-cash return = annual net cash flow / total cash invested
Mortgage Constant and Interest Rates
Sometimes known as the loan constant, the mortgage constant is a percentage comprised of the annual debt service amount to the total value of the loan, including both principal and interest payments. The mortgage constant is important in determining your loan payment. If you know your loan amount and interest rate without knowing your mortgage constant, you may not know your monthly payment. Interest rates are an important factor to consider when getting financing as well, as high rates can lower your income potential.
Mortgage constant = annual debt service / loan amount
Home Price Appreciation
Approach appreciation with caution. Adding speculative appreciation into your calculations can be misleading and has potential to result in a loss if you’re not careful. The fact is, no one knows what the value of a home will do or when. The best way to handle this is to ensure the deal makes sense before factoring in appreciation or depreciation and have a deep understanding of the market in which you’re investing. California investors, for example, are seeing higher appreciation rates with lower yields. Inversely, some markets in the Midwest are experiencing lower appreciation but higher yields. There are even some markets, like Orlando and Atlanta that are experiencing the best of both. Just do your research before you bank on assumptions.
For further information, check out our podcast, The Investability Podcast with Dennis Cisterna for more education and advice.