4 Metrics Every Multifamily Real Estate Investor Needs to Know

Real estate investing is complex. The asset classes’ natural attributes, such as tax advantages and the ability to earn passive income, attract all types of investors, including institutional, retail, and individual investors. However, investing in real estate takes experience and knowledge as not every deal offers the same opportunity to deliver ongoing cash flow and long-term returns. Knowledgeable real estate investors have robust underwriting processes in place to be able to effectively evaluate a market and deals, not to mention the alphabet soup of metrics investors should be familiar with before investing. Our latest article discusses four metrics we believe every multifamily real estate investor should understand before investing.

1 | Equity Multiple

The Equity Multiple of an investment is a ratio that is widely used to help investors understand the total cash return over the life of an investment. It is usually quoted as ‘2x’ or ‘3x’ to signify how many times the money initially invested is worth at the end of the investment lifecycle. For example, assume an investor purchases a property for $100,000 and later sells it for $200,000. In this case, the deal delivers a 2x multiple. Equity multiple is generally used to evaluate investments with longer hold periods. Like most real estate investment metrics, equity multiple is great when evaluated in conjunction with other measures.

2 | Net Operating Income (NOI)

NOI is an asset’s profit before debt service (i.e., mortgage payment) and is a metric widely used by real estate investors. To calculate it, subtract all of the property’s normal operating expenses from its income. It is a useful metric for investors because it helps determine an asset’s profitability without taking into consideration how it is financed. Why doesn’t the calculation include debt service? The answer is simple. Investors want to be able to compare one asset’s profitability to another on an apples-to-apples basis. Including debt service complicates it because the choice of financing impacts the deal. NOI is an important metric for investors to analyze before investing.

3 | Cap Rate

Cap rate is another metric widely used by real estate investors. To calculate, divide a property’s NOI by the price at which it was purchased. Cap rate varies by market, sub-market, and tenant quality, and higher risk investments tend to come with higher cap rates.

Seems straightforward, right? Think again. The cap rate tells you what investors are willing to pay on average for an income stream in the market. For example, if a particular market is trading at a 5 cap, it doesn’t tell you anything about your potential return. Instead, it tells you what investors are willing to pay. The lower the cap rate, the more that investors are willing to pay for a dollar of income and vice versa. Therefore, rather than a return metric, cap rate is the measure of a market’s appetite for risk.

4 | Debt Coverage Ratio (DCR)

Debt Coverage Ratio is an important risk metric that both lenders and investors use. It tells how many times the asset’s NOI covers its debt service. For example, if a deal has a 1.60x DCR, that means that the income remaining after paying operating expenses covers the debt service by 160%. In other words, NOI could decline by 60% before the asset could no longer cover its debt payments. Therefore, the higher this number is, the more protected the lender feels, and the more cash flow will be available to equity investors.

DCR will usually increase over the life of the deal as the spread between income and expenses goes up. However, if you see DCR going down temporarily in a deal proforma, it isn’t always a sign that something is wrong. Suppose a property is refinanced later in the investment lifecycle; this would increase the outstanding loan amount. DCR may temporarily lower until rents catch up with the newly increased loan amount and doesn’t signify anything wrong with the investment. Therefore, it is imperative to understand the details behind the metric before making an investment decision.

The metrics discussed in this article are the four we consider closely before investing. Understanding these metrics will help investors spot opportunities and avoid underperforming investments. To truly understand a deal’s risk/reward profile, one must evaluate each metric as they relate to each other rather than on a standalone basis. Considering these metrics and investing alongside an experienced sponsor can add high-performing assets to your investment portfolio that offer qualities not found in traditional equity markets.