6 Most Important Metrics for Real Estate Investors

Every commercial property has a set of important metrics, which define the alluringness of this or that real estate object. Commercial real estate metrics include yield on cost real estate (or OER), real estate return on investment, and others. We are looking at them in this article.

What is OER in investing and how it is calculated

One of the most important stock metrics is OER (alternatively known as NOI – Net Operating Income), which defines the income that any commercial real estate investor will have on hands as a result of running a property after deduction all operating expenses that are normally borne on a yearly basis to run the object.

The OER is defined in percentage and its formula is as such:

Total yearly operating expenses (TYOE) minus yearly depreciation (YD) divided by gross revenue (GR) multiplied by a hundred percent. It is comprehensible like this:

OER=(TYOE-YD)/GR*100%

All numbers should be given in their yearly values.

Let’s look at this in the following example.

You are running a commercial multi-family rented place. You have 20 apartments generating you $30,000 a month. Your yearly depreciation of the object is 15% of its cost, let’s assume, $55,000. Your monthly expenses to run the object are $20,000. Thus, the formula will be:

OER=(($20,000*12-$55,000)/$30,000*12)*100%=51.39%

Ideally, the lower your OER is the better. In real life, anything between 60% and 80% is considered good enough as a long-term investment.

What is included in the OER? All normal operating expenses, which are connected to running the object:

• maintenance
• insurance
• utilities (water, electricity, pest and rat control, trash removal, pool and landscape management)
• repairs and damage
• management and employee fees
• property taxes
• attorney fees
• marketing (advertising)
• others.

What is not included in OER:

• capital improvements and large renovations or re-building, including the possible construction of new square footage to enlarge your object
• something one-time, which isn’t necessary or recurring, for instance, inviting a painter to decorate walls with paintings.

ROI. Connection of real estate ROI and OER

A good question: why do I exclude depreciation of a commercial object from my real estate metrics OER? Well, because yearly depreciation is not an operating expense – it is the depreciation of capital investment. Also, there is a chance that there is no depreciation at all connected to one of your particular premises – if you sell it after the years of usage with a surplus compared to the price of purchase. It is absolutely possible. However, it is about how much you will gain on your asset when selling it, which is ROI, whilst OER shows you how much you gain yearly on running it, utilizing a particular object as your business asset, which generates the added value. For similar reasons, if you take a loan to pay for your real estate object, the expenses you bear connected to the loan also are not included in OER – they’re included in ROI.

ROI is Return On Investment, which basically defines when your investments in some real estate object will recoup. Let’s say, you spend $2 million to buy one. As derives from the numbers above, you earn $360,000 annually, while spending $240,000 annually on various monthly running. Depreciation consumes another $55,000. What you left is $65,000 annually ($360,000-$240,000-$55,000). ROI will be 30.76 years: $65,000/$2,000,000.

However, this does not show the real profitability of your investment upon selling it, as you could sell it for a bigger price than you’ve bought it. ROI is specifically about how much time is needed so you fully recoup your investment in an asset by managing this asset and gaining profit from it. If you sell it at some point in the future and get, let’s presume, 2.5 million for it, you can calculate the Return On Asset (ROA) indicator, which we describe below. Attention: don’t forget to include loan-connected expenses in your ROI!

What are the other real estate investment metrics?

ROA: Return On Asset. It defines how profitable, in the end, some particular asset is for you. In the given example, if you buy a real estate object for $2 million, sell it in 5 years for $2.5 million, and earn $65,000 annually during these 5 years, then your ROA is such:

ROA=$2.5 million+$65.000*5 $2 million*100%=141.25%

Alternatively, if you swap real estate objects by simply buying and selling, then exclude from this formula the net yearly income. If you buy, improve, and sell, then instead of net yearly income, you should include the losses connected to the improvement/renovation, which will decrease the percentage, not increase it.

Cash flow rent metrics. It is a monthly metric, which says how much money you have left on your hands (if any) after you obtain all your revenues and extract from them all your operating expenses. That typically would not include yearly depreciation and shows how much you actually physically hold on hands monthly. In the example above, your monthly cash flow will be $30,000-$20,000 = $10,000.

Cash on cash return. This is a continuation of Cash Flow only given your loan-connected expenses, which you have in case if you will have bought a property for the loaned money. In the example above, presuming you will have borrowed 1 million of the 2 million in total with a 4% interest rate, which roughly makes a $3,333 monthly loan cost, your cash on cash return is $10,000-$3,333 = $6,667.

Gross Rent Multiplier. This is an indicator, which allows roughly estimating the building market value given all its monthly rent values. It will strongly depend on the current market and comparable properties’ prices. There exist several formulas to calculate it, which you can find online.