Real estate investors exist, as a group, very knowledgeable about the return metrics of their properties. After all, profitability is the main reason for investing in real estate. However, investors only sometimes consider all the critical metrics that matter to their bottom lines. Return on investment (ROI) is often a top consideration for real estate investors, but it isn’t the only one.
Real estate investment can be a challenging yet lucrative business. This article will discuss the most critical metrics for evaluating your return on any real estate deal.
In general, such measurements might indicate whether the return aligns with the amount of risk the buyer is ready to accept.
Return on investment metrics is a way to understand and compare the efficiency of real estate investments. There are many different metrics, but five are essential for real estate investors.
5 Important Return Metrics For Real Estate Investors
- Equity Multiple
Equity multiple is a measure of the return on investment. The higher the equity multiple, the better. It’s calculated by dividing your total annualized cash flow by the purchase price. So if you bought a property for $200,000 and made $10,000 in annual net operating income (NOI), then your equity multiple would be five times. That means that for every dollar you invest into the property, you get 5 dollars back in annual NOI.
In addition to NOI and cap rate, equity multiple is one of the most important metrics to track as an investor because it helps you understand how much money you can make from each property you buy.
- Average annualized return
The average annualized return is the average annual return you can expect from your investment property. This is calculated by dividing the total returns (capital gains, rental income, and other income streams) by the years you’ve owned the property.
Average annualized return = Total returns / Number of years owned.
For example, $15,000 capital gain + $10,000 rental income + $1,000 interest income = $26,000 total returns. If you have owned the property for ten years, your average annualized return is 26% per year.
- Cash on cash
Cash on cash is a metric used by real estate investors to determine the amount of money they make on each dollar invested in their business. It is calculated by dividing the annual cash flow by the capital required to generate that cash flow.
Cash on cash return is an essential metric for real estate investors because it helps them determine whether they are earning a profit on their investment. If your cash-on-cash return is low, you are losing money and need to either sell the property or increase your returns to break even.
Cash on Cash Return = Annual Cash Flow / Invested Capital
- Internal Rate of Return (IRR)
IRR is a metric that calculates the percentage of your money you make on an investment over a year (usually one year). It is calculated by determining the interest rate you need to earn to get the same return as your investment.
For example, let’s say you invest $100 and receive $110 at the end of one year. Your IRR is 10% because if you could invest $110 for one year at 10% interest, you would have $111 at the end of that year.
However, if instead of receiving $110 at the end of one year, you received $100 back after six months and then another $100 at the end of another six months, then your IRR would be -5%. This sounds strange because we usually consider IRRs positive numbers (after all, real estate should be positive!). But since returns are never guaranteed, it is essential to look at them from every angle possible
- Preferred Returns
All real estate investors are looking for the same thing: preferred returns.
Preferred returns are a way to measure how well your investment is doing in comparison to other assets and investments in your market.
Conclusion
Return metrics are a vital tool in real estate investing. They help investors measure their progress, set goals, and determine if they are making the right decisions. While calculating each of these metrics is slightly different, they are all useful in helping investors choose if they are making the right decisions with their money. It is also important to note that specific metrics are more vital than others. However, investors should always look at each of these metrics, as it gives them a complete understanding of the success. To know more about investing in real estate, contact Terra Equity Group.
