The Numbers to Know in Real Estate Investing

Fundamental Principle

There are a plethora of numbers investors can use to evaluate real estate opportunities and returns - knowing your strategy and desired outcomes will help you focus on the right numbers at the right time. Here are the metrics we consider critical!

LTV, ARV, CapEx, NOI: Real Estate Investors love a good acronym! As a new investor, it's easy to feel intimidated and hold back from asking questions you think you should already know.

It's easy enough to google these acronyms and get answers - and even go down the rabbit hole. Our goal is not to recreate the wheel and share more of what already exists - but rather to give you a cheat sheet that consolidates this information in an opinionated fashion. How you choose to run your numbers and the outcomes you value in real estate will be distinct to you - and will likely evolve. Here are the KPIs we consider at different phases when evaluating a particular market, property, or our entire portfolio - we hope this proves a good launching pad for you!

KPIs for Evaluating Markets, Properties, and Your Portfolio

Rent to Value Ratio

Why it Matters: Knowing the Rent to Value ratio helps you determine whether a market (or particular property) is potentially a strong investment market for cash-flowing real estate. Have you heard of the 1% and 2% rules? This ratio lives at the heart of those rules - and provides directional data as to whether or not you want to continue investing time in evaluating a market or property.

How to Calculate: This is an area of debate!

Some investors calculate rent to value as rents vs. acquisition + rehab cost when referring to a particular property. We prefer calculating rent vs. ARV - as it gives you a more accurate picture of the ratio once you stabilize the property. In our experience, lenders base the loan on the backend of the process (should you plan to refinance post-rehab) on the ARV. Calculating based on your costs (acquisition + rehab) will give you a sense of your first few months into the project - and might be a helpful way to evaluate the property if tenanted when you purchase.

If evaluating a market in general, we'd strongly recommend using ARV and looking at updated properties (of the same quality you'd plan to purchase/upgrade your rentals). As a rule of thumb (and who doesn't need another one of those 😉), you can rule out a market or property where your Rent to Value Ratio is below .5% - if you're investing for cash flow.

When to Use It:

• Evaluating a market's viability for cash flowing investments
• Determining the potential cash flow for a particular property

Physical Occupancy Rate vs. Financial Occupancy Rate

Why It Matters: These metrics have a massive impact on your cash flow for both long-term and short-term-rentals.

How To Calculate:

• Financial Occupancy: What % of the year are you receiving rent payments for the property?
• Physical Occupancy: What % of the year is the property rented by a tenant?

When to Use It:

• Financial Occupancy is a crucial metric when considering a specific property or market, especially when considering a short-term rental. There is no national metric you can or should lean on - you need to get granular with your market and property type by speaking to PM's and fellow investors.
• Evaluating portfolio health on a monthly basis

After Repair Value (ARV)

Why It Matters: ARV tells you how much a house will be worth once repairs and capital improvements are complete. It's a projection based on comparable properties.

How To Calculate: We wish this was more of a science - we've found it to be an art. There are a few ways to evaluate:

• Identify similar comparable properties, and calculate the $/square foot - apply to your property
• Identify similar comparable properties with the same floorplan and square footage - and identify the possible range for your property (i.e., 110,000-120,000).

If you're taking approach number one - sense check when you complete. If your $/sq. foot calculate comes out significantly higher or lower than other properties recently sold in the market - it's worth asking why! Hint: If you're working with an agent, ask them for a CMA and second opinion. Run your own numbers, always - but get a second opinion. If you're not working with an agent but aren't an SME in a particular neighborhood - run your numbers by a fellow investor for their thoughts!

When to Use It:

• Evaluating a particular property and determining your best offer

Cash Flow

Why It Matters: Simple - if it's negative, you're losing money every month and have to fund the property from your W2 or other investments. Generally, we don't recommend investors purchase negative cash-flow properties - as this likely indicates you're betting heavily on appreciation and ignoring market fundamentals.

How To Calculate: NOI - Debt Service - Capital Improvements

When to Use It:

• Running your monthly numbers and evaluating portfolio health
• Evaluating a potential purchase

Internal Rate of Return (IRR) - Return on Equity (ROE) - Return on Investment (ROI)

Why it Matters: IRR gives you an understanding of most (if not all) of a particular property's returns. It's a vital metric to consider, as it gives you a comparison point with other asset classes to ensure it makes sense to invest in real estate and this particular deal. Investing in real estate comes with risk - and you need to ensure the return is there before you invest. IRR is also important to watch as you hold the property - as it guides your thinking about whether the asset is worth continuing to hold, should be refinanced, etc.

How to Calculate: But wait - isn't that ⤴️ just ROI? 🤔We've linked IRR, ROE, and ROI above - as depending on the point in time, IRR is equivalent to ROE or ROI.

Year One: In year one, it generally makes sense to link IRR with ROI. IRR should include all the ways you make money in real estate (Cash Flow, Loan Pay Down, Appreciation, Inflation Hedging, Tax Benefits). That said, most investors struggle to calculate inflation hedging and tax benefits accurately - so we tend to focus on the first three for our numbers.

Y1 Formula, No-Refi: (Cash Flow + Loan Pay Down + Appreciation) / (Down Payment + Rehab Expense)

Y1 Formula, Refi: (Cash Flow + Loan Pay Down + Appreciation) / ($ locked in the deal)

Year Two & Beyond: After year one, we recommend calculating IRR as Return on Equity (ROE). ROI becomes less relevant the longer you hold an investment (as you realize your acquisition costs and major rehab costs in Y1), while ROE gives you visibility to whether you should be refinancing//selling the property.

Y2+ Formula: (Cash Flow + Loan Pay Down + Appreciation) / (Equity in the Property)

When to Use It:

• Evaluating real estate returns vs. other assets (stock market, etc.) - note: you can get a sense of potential IRRR from other investors in that market working in a similar asset class (single-family residential, small multi-family, large multi-family).
• Evaluating whether or not you should purchase a potential property - but note: we'd recommend focusing on cash flow & loan pay-down here. Never bet on appreciation to make the numbers work!
• Evaluating how your portfolio is performing at a given point in time
• Evaluating options to keep your equity working for you, such as refinancing or selling the property

Net Operating Income (NOI)

Why It Matters: Net Operating Income enables you to judge a property's ability to generate revenue and profit - and tells you whether a specific investment will generate enough income to cover debt service (i.e., mortgage payments). NOI enables a seller to provide a sense of property profitability without taking every buyer's unique debt service (and thereby, expenses) into account.

How To Calculate:

Income Generated From The Property (Rents + Pet Fees + Laundry Fees, etc.) - Operating Costs (PM Fees, Taxes, Insurance, Repairs, etc.)

Note: This does not include your debt service! You're using this formula to understand what debt service this property can support. It also does not include capital expenditures that fundamentally improve the property (such as a major kitchen remodel or new roof) as they should improve the income figure. Distinguishing repairs from capital expenditures can become fuzzy - but keep that "improves the property" vs. "returns the property to rent-worthy conditions" line in mind!

When to Use It:

• Purchasing a property and evaluating debt service options, especially a Turnkey investment
• Refinancing a property
• Evaluating a turnkey investment

Capitalization Rate (Cap Rate)

Why It Matters: Cap Rate can be most closely compared to a stock market ROI. Cap Rate is the ratio between the amount of income a property generates to the original capital invested (or its initial value). Cap Rate tells you the % of the investment's value that is profit.

How To Calculate: NOI / Sales or Purchase Price

When to Use It:

• Buying or selling a multi-family or commercial property

KPI's for Financing

Loan to Value Ratio (LTV)

Why it Matters: LTV is an essential metric to understand - as it tells you how much a lender is willing to lend against a particular property. Knowing LTV tells you the amount of leverage you can take on - most banks target 75 - 80% - which means you'll lock 20-25% in the deal.

How to Calculate: Your lender will tell you the LTV they're comfortable providing.

After-Repair Value (ARV) * LTV = Total Loan Amount

You can plug that total loan value along with your ARV into your BRRR (Buy, Rehab, Refinance, Rent) formula to understand how much you might be able to pull out of the deal (hint: it doesn't have to be 100% of your investment to be a great property).

When to Use It:

• Evaluating potential loan options

Cash on Cash Return (CoC / Cash on Cash)

Why It Matters: CoC tells you the total return on the actual cash you've invested.

How To Calculate: Annual pre-tax cash flow / total cash invested

When to Use It:

We're not fans of this metric - but it's so common we thought we'd include it. We'd suggest using IRR both for projecting possible returns and evaluating your current portfolio - as it takes into account the full picture of loan paydown and appreciation (looking back only) and also considers your tax rate.

If you want to calculate CoC return, we recommend using it only to project into the future.

• Evaluating the impact of different debt service options on your cash flow for a particular investment

Debt Service Coverage Ratio (DSCR)

Why It Matters: When securing a commercial loan (which you might do on residential properties and commercial), most lenders will expect you to know and understand this metric. A healthy DSCR ensures you can cover all expenses covered with a particular property.

How To Calculate: NOI / Monthly Mortgage Payment (Principal + Interest). Most lenders require this to be 1.2 or higher.

When to Use It:

• Financing or refinancing a property

You hear "know your numbers" a lot in real estate - and it can be overwhelming to know which numbers you need to know and when! We hope this (somewhat) opinionated guide to the standard metrics helps point you in the right direction and avoid the information overload that comes with learning real estate!

What do you think we got wrong? What metrics do you think are critical? Drop us a comment and let us know!