Which Financial Metrics Should Landlords Track?
Tracking and understanding key financial and real estate investing metrics are critical parts of being a landlord.
If you want to build a better business, you need to know where you’ve been and where you’re going.
Financial metrics allow you to assess the financial health of your business and make informed decisions moving forward as a real estate investor.
In this article, we’re going to talk about the real estate metrics you need to track and why you need to track them for each real estate investment.
Net Operating Income (NOI)
NOI or net operating income is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the real estate investment property, minus all reasonably necessary operating expenses. Don’t include your mortgage payments in the NOI calculation because those aren’t considered operating expenses.
Operating expenses include things like property manager fees, legal fees, general maintenance, property taxes and any utilities you cover in your real estate business.
The calculation excludes capital expenditures, taxes, mortgage payments, and interest.
NOI is typically a key part of determining profitability for commercial or residential rental property investments. Lenders and real estate investors often use NOI to assess a property. By looking at this measure, lenders can judge whether investors will have enough cash flow to make loan payments. Lenders sometimes use a property’s net operating income if they want to know if investors are likely to pay back a loan when considering the potential cash flow.
There are downsides to using net operating income, though. Projected rents could prove inaccurate, which would have a negative impact. Furthermore, if the building is improperly managed, income might be inconsistent.
Internal Rate of Return (IRR)
IRR estimates the interest you’ll earn on each dollar invested in a rental property over its holding period. This calculation goes beyond net operating income and purchase price to predict long-term yield.
When you calculate IRR, put the net present value (NPV) of the property at zero and use projected cash flows for each year you plan to have the building. NPV is the value of money now instead of in the future after the money accrues compound interest. It’s a complex formula, so it would be wise for most of us to use the IRR function in Excel to determine the ratio.
While it’s a helpful measure, IRR does have limitations. It assumes a stable rental environment and an absence of unpredictable repairs. The properties you compare should be similar in size, use, and holding period.
Cash Flow
Cash flow is an indicator of how your business is doing in the current real estate market. It shows you your net cash left at the end of the month after you’ve collected rent payments and paid expenses. As an example, if you rent out a building for $2,500 a month, and all costs are $1,500, your net cash flow is $1,000.
Don’t let the simplicity of this one fool you; cash flow is a key metric. If it’s negative, you won’t be able to pay your bills or turn a profit. Negative cash flow could also be a sign that you need to examine your expenses more closely. Or it may indicate that you have a problem tenant whose late or partial payments are hurting your bottom line. Positive cash flow is one of the main factors investors look for before adding a new property onto their real estate portfolio.
Effective Rent
Effective rent is the actual rent rate a landlord achieves after deducting any concessions given to the tenant (for example, a free month’s rent, a moving allowance, etc.). Effective rent is calculated by multiplying the gross rent amount by the length of the lease, then subtracting the discounted months or other concessions given to the tenant.
By taking into account concessions and discounts, effective rent provides you a clearer picture of your true rental costs over the lease term.
This can help you budget more accurately for upcoming years and compare leasing options more fairly. Knowing your effective rent can also help you negotiate better terms, understand the affordability of different properties, and avoid unexpected expenses.
Gross Yield
Gross yield is crucial in market rent analysis as it helps determine the potential return on investment. It is expressed as a percentage representing profit before deducting taxes and expenses.
By calculating gross yield, investors can assess the profitability of a property before factoring in additional expenses.
This metric serves as a foundational element in real estate financial planning, providing insight into the property’s earning potential. Therefore, gross yield is fundamental for making informed decisions in real estate investments.
Return on Investment (ROI)
ROI is a critical metric. This metric reflects how much income your property produces versus the amount of money you invest to maintain it. The basic formula is annual returns divided by the cost of the initial investment.
ROI is important because it helps reveal how healthy your business is from a financial standpoint. It helps investors understand how well a property is doing and reveals areas which may need improvement.
Gross Rent Multiplier
The Gross Rent Multiplier (GRM) is the ratio of a property’s market value to its yearly gross rental income. It serves as a comparison tool for assessing the potential of properties with varying market values, starting costs, and potential rental income.
Your GRM is calculated by dividing the Fair Market Value (FMV) of the property by your gross rental income. FMV is equivalent to the price the property would sell for assuming open market activity (this value can be obtained by getting a professional appraisal). Gross rental income is the total amount of income you receive from a rental property, before subtractions for operating expenses.
Low GRMs are better—a GRM between 4 and 10 is generally considered “strong,” or a sign that the property will make a good investment. However, GRM is mainly used as a comparison tool, so a single property’s GRM doesn’t necessarily tell you how good of an investment it will be.
Occupancy Rate
Occupancy rate is a vital metric for every landlord and property management company. It lets you know how appealing your property is in the current market. You calculate it by dividing the number of occupied units by the total number of units on your property, then you multiply the result by 100 to get a percentage.
A high occupancy rate means that your rental property is in demand. It also means you’re making money from your property.
On the other hand, a low occupancy rate may signal that your rental property isn’t competitive in the market or that you need to make improvements to appeal to tenants. You should use this as a warning sign that you need to reevaluate your rental rates, marketing strategies, or the condition of your property. Vacant units are costly and something you want to avoid because the negative consequences compound over time.
Tracking your occupancy rate over time also helps you spot trends and patterns in tenant behavior. For instance, if you notice a seasonal trend where tenants tend to move out during the winter months, you may want to adjust your marketing and pricing strategies to account for this trend.
Tracking your occupancy rate also leads to informed decisions about when to make upgrades or improvements to your rental property.
Rental Income
It might be the most obvious metric, but it also might be the most important. Rental income is the total amount of money that you receive from your tenants each month or year. It’s a vital metric because it highlights the financial performance of your business.
By tracking rental income, you ensure your prices are fair and that you’re generating enough income to cover your expenses. This metric also helps you calculate your gross rental yield, which is the rental income earned as a percentage of the property value. You can use this to compare the performance of your property to similar properties in the same market.
Several factors impact your rental income, including the condition and location of your rental property, the demand for rental properties in your area, and the rental rates charged by competitors. Tracking this metric allows you to understand what changes in these factors might benefit your business.
Beyond tracking rental income, you should also keep detailed records of any rental payments and deposits received from tenants. This will help you to ensure that you are collecting the correct amount of rent and protects you in case disputes over rental payments or security deposits arise.
Conclusion
While this isn’t an exhaustive list of every important financial metric (many investors also track their debt service coverage ratio, operating expense ratio, loan to value ratio, cash on cash return, and many others), these are all key metrics you need to track for rental property accounting.
Your business cannot improve if you don’t understand trends, analyze metrics over time and educate yourself.
