Updated: Feb 16
Investing in multifamily properties can be extremely profitable when it is done correctly.
However, in order to make ideal real estate investments, real estate investors need to be aware of certain KPIs for multifamily properties. Only by carefully analyzing these KPIs can you properly assess potential real estate investments to identify the best ones.
Here, we'll be discussing the top 5 most crucial investment KPIs for multifamily properties. This should help you have a much better understanding of what to look for:
Net Operating Income (NOI)
Net operating income tells you exactly how much money a property is generating per year after subtracting the expenses. The formula for NOI is annual income – annual expenses. NOI appears on a property’s income and cash flow statement. It is a pre-tax figure.
This figure is extremely important because it lets you know how much money a property is actually making. Some properties have large incomes but they also have large expenses. The goal is to look for properties with large NOIs, not just large incomes because if expenses are too high, it can cut into your profits.
Debt Coverage Ratio (DCR)
Debt coverage ratio is a measure of a property’s income compared to its debt. Debt coverage ratio is also referred to as debt service coverage ratio. The formula for DCR is NOI/Annual Debt obligations. So, for example, let’s say a multifamily property had a NOI of $1,000,000 and had annual debt obligations of $500,000.
To calculate DCR for this property you would divide $1,000,000 by $500,000. This would give you a DCR of 2. DCRs over 1 are considered to be good and DCRs below 1 are considered to not be good. Oftentimes, lenders will even require DCRs to be at least 1.15-1.25 in order to approve mortgage loans. So, when you are evaluating properties, the higher the DCR, the better.
Capitalization Rate (Cap Rate)
Cap rate is a metric that is used to measure the rate of return on a particular property. The formula for calculating cap rates is NOI/Property Value. Cap rates give you an idea of how long it will take to recoup your initial investment. This is a very good thing for a real estate investor to know because real estate investments are only profitable after the initial investment has been fully recouped.
To understand cap rates, let’s say that a property’s value was $1,000,000 and its NOI was $100,000.
In this circumstance, if you wanted to calculate cap rate, you would divide $100,000 by $1,000,000, which would give you .10. You can then multiply the cap rate by 100 to see it as a percentage. So, .10 x 100 = 10%. This means that for this property, you would recoup 10 percent of your investment per year and it would take 10 years to fully recoup it. If a property has a lower cap rate it is generally considered to be lower risk, but will take longer to recoup your investment.
If a cap rate is higher, it is considered to be a higher risk, but it will take a shorter amount of time to recoup your investment. As a real estate investor, you will have to decide what level of risk you want to deal with and how important it is to get your money back quickly. Cap rates between 5 and 10 percent are considered average.
Gross Rent Multiplier (GRM)
The gross rent multiplier is a metric that explains how the price of a property relates to the rental income for that property. The formula for gross rent multiplier is price/rent. To understand how this works, let’s assume the price of the property is $500,000 and the rental income per year is $50,000.
To calculate the gross rent multiplier for this property, you would have to divide $500,000 by $50,000. $500,000/$50,000 = 10. So, the GRM for this property would be 10. Many people consider GRMs of between 4-7 to be ideal. This is because the lower the GRM, the more money that your property will generate relative to its fair market value.
Cash on Cash Return (COCR)
Cash on cash return, also known as COCR is a measure of the annual return that the investor made on a property relative to the mortgage paid for the same year. It is calculated on a pre-tax basis. The formula for calculating COCR = Annual Pre-Tax Cash Flow / Total Cash Invested.
For example, let’s say you have a property with an annual pre-tax cash flow of $20,000 and your total cash invested was $150,000. In this case, to calculate the COCR, you would divide $20,000 by $150,000 and you would get .13333 or 13.3%.
A good cash-on-cash-return in today’s economic climate is considered to be anything at least 5-8 percent or higher. So, 13.3% would be a very good cash-on-cash-return. Many real estate investors will not invest in a property unless it has a COCR of at least 5%.
Which Real Estate Metric is the Most Important?
The short answer is that they are all important.
Therefore, you want to use as many of them as possible when you are evaluating a potential real estate investment. There is not one simple answer.
Also, some real estate investors prefer certain metrics over others. For example, some real estate investors prioritize cap rates and others prioritize gross rent multipliers.
The bottom line is that before you decide to invest in a property, you have to make sure that the numbers line up. If you are unsure of which of these metrics to use, then you should just use all of them to avoid the risk of neglecting one and then making a mistake because of it.
Why Do Numbers Matter in Real Estate Investments?
The numbers matter in real estate investing because not all real estate investments are equal. The end goal of real estate investing is to get the best possible return on your investment. However, there are many different factors that can affect ROI such as purchase price, expenses, neighborhood, rent prices, etc.
The metrics listed in this blog are designed to give real estate investors key insights into whether or not they will be able to recoup enough of their money in a fast enough amount of time, with a low enough amount of risk, in order for a real estate investment to make sense.
But, while numbers are important, they are not the only thing that matter. You should also consider current market conditions, neighborhoods, crime rates in the neighborhood, the appearance of the building, the state of the appliances, how easy it is to get tenants for the building, etc.
If you do not want to do all of this work yourself and work out all of the numbers, then you can always work with a multifamily sponsor. A multifamily sponsor is a professional company that specializes in multifamily property investing that can use their expertise to find properties for you that you can invest your money in.
Many of these businesses have professionals with many years of experience calculating cap rates, COCR, etc., and know exactly how to find buildings with the best numbers. It can be far easier to work with a multifamily sponsor to find real estate investments than to try to do it all yourself.
Invest with Blue Lake Capital
About Ellie Perlman
Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.