Regardless of one’s experience, evaluating the performance of real estate is complicated and quantitatively heavy. An assortment of ratios and metrics capture property performance but interpreting these ratios and gathering the necessary data to calculate them is difficult. Here are some key ratios that you should calculate and refer to if you want to assess your property’s performance.
Net Operating Income
This is the first, and perhaps most important, metric of your property’s profitability. Net operating income refers to your rental income, net of the expenses incurred from operations, such as insurance, maintenance, and management. In isolation, net operating income will not tell you everything that is relevant to your property’s performance. However, it still conveys your property’s capacity to generate income.
Debt-Service Coverage Ratio
Once you’ve calculated your net operating income, you can calculate your debt-service coverage ratio: this is your net operating income divided by your total debt obligations.
Net operating income reflects your property’s ability to generate income. In contrast, your debt-service coverage conveys your ability to service your debts with the income generated by your property. The higher the ratio, the better your financial situation.
Net Present Value
Net present value tells an investor whether their future rental incomes have a present value large enough to justify the present investment. Due to inflation, money does not have a fixed value. Consequently, $100 today may be worth more than $100 tomorrow because of inflation. Suppose $100 could buy 10 units of some basket of products that’s used to calculate inflation. Suppose this basket’s price is inflated by 100% (an extreme example). Now, $100 can only buy 5 units of that basket. So, $100 today is worth $200 tomorrow.
This is the principle behind net present value. Future rental incomes are calculated and then discounted to reflect their present value. An investor uses this information to assess if the property’s income justifies the present investment.
Cash-on-Cash Return
This ratio is calculated by dividing net annual cash flow by the cash investment. The ratio tells you how much cash is returned to you (not generated) by every dollar you invest in a property. If you invest $10,000 and your annual cash flow is $1,000, every dollar returns $0.10 to you. Cash is the most liquid asset available to you, so this is an important indicator.
If you want a property evaluation analysis that accounts for these ratios and more, contact us, at Harmon/Harmon. We’re a CPA firms specializing in real estate and investment property evaluation analysis in Austin, TX. Get in touch, and we will make sure your decisions are underpinned by accurate information.