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The 4 Most Important Metrics for Passive Investors in Real Estate

As a passive investor, it’s critical to make smart decisions when investing. You are in it for the long haul and the real estate must be worth it. When putting your money in multifamily real estate, it’s vital to consider the metrics involved in the selection. What are the most important metrics for passive investors in real estate?

Here are the five most critical metrics for passive investors in real estate: 

  • Internal Rate of Return (“IRR”)
  • Capitalization Rate
  • Cash On Cash Return
  • Equity Multiple 

These will make a difference in your investing strategies.

If you’re interested in learning more about the most critical metrics for passive investors in real

estate, you’ve come to the right place. Read on to learn about the most vital items in this area to make the most intelligent investments in multifamily real estate.

Internal Rate of Return (IRR)

When evaluating a prospective investment, one of the first things investors want to know is

how much is the property expected to make. Unlike ROI (Return on Investment) or ROE (Return on Equity), IRR takes into consideration the length of time of the investment or the future value of capital. To put it simply, IRR is the figure used to evaluate the expected annualized return on a multi-year investment.

For example, an investor receives $50,000 over a period of 5 years over $100,000 investment, that’s a 50% return on investment, 10% a year. However, to claim an investment is yielding 10% per year, the investment must be growing by 10% marginally each year, not 10% of the original total.

In this case, a 10% marginally return a year each year will yield a total of $66,349 over the course of 5 years, rather than $50,000. Therefore, a $50,000 total return in five years would have an IRR of about 8.45% instead of 10%.

Capitalization Rate

The cap rate is the yield you can expect to receive from a given investment. Cap rate is useful for comparing different investment options  Investors will want to select properties with cap rates that are higher because this means that the yield on their investment will be higher. Now does this means a higher cap rate is always better than a lower cap rate? That depends on where the property is located, is it a primary or secondary market, a C-class building or an A-class building, etc.?  

By definition, cap rate is calculated by dividing the annualized net operating income by the current market value or cost to acquire the property. Suppose that the property you own is currently valued at $2000,000 and the property is generating an annualized net operating income of $100,000. To calculate the cap rate, you would simply divide $100,000 by $2000,000, producing a final cap rate of 5 percent.

An operator can effectively increase the value of the property by implementing value-add strategies to increase the net operating income. There are two main ways to improve the NOI of the property: to boost revenue, such as rents or adding additional services and to reduce operating expenses.

Cash On Cash Return

Cash on cash return (CoC) is a financial metric used to evaluate the profitability of an investment in real estate. In multifamily real estate investing, cash on cash return is typically calculated as the annual pre-tax cash flow divided by the total amount of cash invested in the property.

You can use this number to determine how long it will take you to earn your money back from the investment. If you invested $100,000 and your flow was $25,000, it would only take four years to make back the money spent.

Cash on cash is the annual cash flow divided by the total amount of cash invested in the property. For example, if you invested $100,000 into a multifamily and you receive $8000 a year in distribution, your cash on cash return for that year would be 8%. A higher cash on cash return indicates a more profitable investment. However, investors should consider other factors such as the potential for appreciation, tax benefits, and overall risk when evaluating the potential return on a multifamily investment.

Equity Multiple

Equity multiple is a metric used to measure the total return on investment. Equity multiple is calculated by dividing the total cash distribution an investor receives from an investment plus the initial investment by the initial investment amount. For example, an investor invested $100,000 into a deal and received $100,000 of total return, the investor’s equity number is 2X ($200,000/$100,000).

The equity multiple is a great metric to use when comparing the potential returns of different investments. The higher the equity multiple, the more attractive the investment. However, it is important to note that this is just one of the several metrics that should be considered when evaluating a real estate investment opportunity. The investor should always consider other risk factors and metrics such as cash on cash, IRR, capitalization rate, and more when evaluating a real estate investment opportunity.