Buckingham Investments will conduct an investment property analysis, from start to finish so that you can evaluate the decision of whether a particular property is worth pursuing. We will work with you on evaluating a property’s rental potential given its location, target tenants and putting together a strategy for future growth potential. Another step is to perform a comparative market analysis on the property.
In the world of multifamily real estate, it’s common for a seller to provide the buyer with a pro forma, which includes information about factors like the amount of rental income the property generates from monthly rent, operating expenses and utility information. At Buckingham Investments we work to provide our own due diligence when looking up figures for a property since any figures we receive from the seller are likely to be shown in their best light.
Once all the data is obtained, it’s time to analyze the property by looking at some key metrics, which will give you a better idea of whether a rental property will ultimately be a profitable investment. However, comparing your apartment building to others down the street to see how much its worth is not always the best approach. That’s why real estate investment analysis is so important. Here are a few real estate metrics when doing an investment analysis:
Net operating income (NOI)
When it comes to analyzing metrics, your first step should be to find the net operating income for the property. NOI is a measure of the income the property will generate after accounting for operating expenses but before debt service (mortgage payments). While NOI is not enough to get a full picture of the profitability of a property, it does form the basis of many other equations you’ll use in your analysis.
The formula for net operating income is as follows:
Rental income + other income – operating expense = NOI
Cash-on-Cash Return
After you know your net operating income, calculate your cash-on-cash return.
The formula for cash-on-cash return is as follows:
Cash flow ÷ the amount you paid for the property (include closing costs, the cost of any repairs, and any other initial expenses, “investment basis”) = Cash-on-Cash Return
Your cash-on-cash return tells you your liquid cash return on investment relative to the amount of money you’re investing to acquire it.
Capitalization Rate (Cap Rate)
Next, you can find the capitalization rate (also known as the “cap rate”)
The formula for capitalization rate is as follows:
Net operating income ÷ the property valuation = Cap Rate
A higher cap rate indicates a greater amount of risk and a higher potential for reward. There’s no ideal cap rate to aim for as every investor must decide independently where their comfort level exists. Working with Buckingham Investments we know the market cap rate for particular areas, so we use this equation to determine how your investment property stacks up against the competition.
Gross Rent Multiplier (GRM)
The GRM is a simple metric you can use to compare properties to each other or approximate value.
The formula for Gross Rent Multiplier is as follows:
The property valuation ÷ Property’s annual gross scheduled rents = GRM
GRM is a useful metric because it simply measures the relationship between gross revenue and value. Because it excludes expenses, it’s easier to use on properties that have limited operating information and is not as prone to manipulation as cap rates. Another way to think about the GRM is that it’s the cost or value for every $1 of annual rent revenue a property generates. GRM is the number of years the property would take to pay for itself in gross received rents.
Cash Flow
Cash flow is the money left over after all the bills have been paid.
The formula for cash flow is as follows:
Income – Expenses – Debt Service = Cash Flow
Remember income may include more than just the rent, and expenses will include more than just the mortgage. You need to take into consideration all income from the property and all expenses from the property. Learn more here.
Return on Equity
Another important factor you must consider is the return on equity also known as ROE. What is equity in real estate? In simple terms, it’s the amount of cash you would put in your pocket if you sold your property today.
The formula for ROE is as follows:
Total Annualized Return {Cash Flow + Principal Pay Down + Appreciation} / Equity = Return on Equity (ROE)
Real estate investors can use return on equity to determine if they should hold on to an investment property or sell and redeploy that capital somewhere else.
Armed with the information Buckingham Investments will provide you in the full analysis, you should be able to make informed choices about whether the property in question makes for a good real estate investment.
