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Financial Ratios for Multi-Family Property Investors
In the world of multi-family property investments, understanding key financial ratios is essential for real estate companies to make informed decisions and maximize returns. Equally important is the role of real estate accounting in tracking and managing these crucial metrics. With accurate and timely accounting, investors can monitor performance and make adjustments as needed to ensure financial performance is being maximized.
In this guide, we will explore the top 10 financial ratios for real estate companies investing in multi-family properties, along with their definitions, guidelines for what is considered good, and example calculations to help you better understand their significance.
Gross Rent Multiplier (GRM)
This ratio measures the relationship between the property’s price and its potential rental income, allowing investors to compare properties quickly. A lower GRM generally indicates a better investment opportunity.
GRM = Property Price / Gross Annual Rent Income
Example: Property Price = $1,000,000, Gross Annual Rent Income = $100,000
GRM = 1,000,000 / 100,000 = 10
Capitalization Rate (Cap Rate)
This ratio indicates the property’s potential return on investment, with higher rates generally indicating better investment opportunities. A higher Cap Rate, typically above 5-6%, generally indicates a better investment opportunity.
Cap Rate = Net Operating Income / Property Price
Example: Net Operating Income = $70,000, Property Price = $1,000,000
Cap Rate = 70,000 / 1,000,000 = 0.07 or 7%
Cash-on-Cash Return (CoC)
This ratio compares the annual pre-tax cash flow to the total cash invested, providing insight into the investment’s cash yield. A higher CoC, typically above 8-12%, is generally considered a good return.
CoC = Annual Pre-tax Cash Flow / Total Cash Invested
Example: Annual Pre-tax Cash Flow = $25,000, Total Cash Invested = $200,000
CoC = 25,000 / 200,000 = 0.125 or 12.5%
Debt Service Coverage Ratio (DSCR)
This ratio determines the property’s ability to cover its debt obligations, with a higher ratio indicating a stronger ability to meet debt payments. A DSCR above 1.2 is generally considered good.
DSCR = Net Operating Income / Total Debt Service
Example: Net Operating Income = $70,000, Total Debt Service = $50,000
DSCR = 70,000 / 50,000 = 1.4
Operating Expense Ratio (OER)
This ratio measures the proportion of income used to cover operating expenses, helping investors identify properties with efficient management. A lower OER is generally preferable, with values below 50% considered good.
OER = Operating Expenses / Gross Operating Income
Example: Operating Expenses = $30,000, Gross Operating Income = $100,000
OER = 30,000 / 100,000 = 0.3 or 30%
Loan-to-Value Ratio (LTV)
This ratio compares the loan amount to the property’s value, providing insight into the level of financing risk associated with the investment. An LTV below 75% is generally considered good.
LTV = Loan Amount / Property Value
Example: Loan Amount = $750,000, Property Value = $1,000,000
LTV = 750,000 / 1,000,000 = 0.75 or 75%
Break-Even Ratio (BER)
This ratio measures the percentage of income required to cover operating expenses and debt service, indicating the property’s financial stability. A BER below 85% is generally considered good.
BER = (Operating Expenses + Debt Service) / Gross Operating Income
Example: Operating Expenses = $30,000, Debt Service = $50,000, Gross Operating Income = $100,000
BER = (30,000 + 50,000) / 100,000 = 0.8 or 80%
Net Operating Income (NOI)
This value represents the income generated by the property after deducting operating expenses, highlighting the property’s profitability. A higher NOI is generally considered better, as it indicates a more profitable property.
NOI = Gross Operating Income – Operating Expenses
Example: Gross Operating Income = $100,000, Operating Expenses = $30,000
NOI = 100,000 – 30,000 = $70,000
Cash Flow After Taxes (CFAT)
This value represents the cash flow available to investors after accounting for taxes, providing insight into the property’s cash yield potential. A higher CFAT is generally preferable, as it indicates a better cash return on investment.
CFAT = Net Operating Income – Annual Debt Service – Taxes
Example: Net Operating Income = $70,000, Annual Debt Service = $50,000, Taxes = $5,000
CFAT = 70,000 – 50,000 – 5,000 = $15,000
Price-to-Earnings Ratio (P/E)
This ratio compares the property’s price to its earnings, allowing investors to gauge the property’s relative value compared to other investments. A lower P/E ratio generally indicates a more attractive investment opportunity.
P/E = Property Price / Net Operating Income
Example: Property Price = $1,000,000, Net Operating Income = $70,000
P/E = 1,000,000 / 70,000 = 14.29
The effective use of these financial ratios individually or in combination can greatly assist in evaluating the potential profitability, financial stability, and overall performance of multi-family property investments. However, it’s important to remember that the guidelines provided are general and may vary depending on the market, location, and property type. Thorough analysis of each investment on a case-by-case basis is essential, as is considering factors beyond these ratios. Accurate real estate accounting plays a significant role in this process, as it ensures that the data used in these calculations is reliable, allowing investors to make informed decisions when investing in multi-family properties.
Should you ever need any assistance with your real estate bookkeeping or virtual property management, don’t hesitate to reach out to REA!
