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What are the best financial ratios to use for evaluating property performance?

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If you own or manage a property, you need to monitor its financial performance regularly. But how do you measure and compare the profitability, efficiency, and value of your property? One of the most useful tools for property analysis is financial ratios. These are numerical indicators that express the relationship between two or more financial variables. In this article, we will explain what are the best financial ratios to use for evaluating property performance and how to calculate and interpret them.

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Emilian Balan

Country Manager
Syed I.

Strategic and Analytically driven Finance Professional
Omar Sarfraz, MBA

at PwC | Real Estate Strategy & Deal Advisory | Value Creation for High-Impact Real Estate Projects

1 Gross Rent Multiplier

Gross rent multiplier (GRM) is a ratio that measures how many years it would take for a property to pay for itself based on its gross income. It is calculated by dividing the property's market value by its annual gross income. For example, if a property is worth $500,000 and generates $50,000 in gross income per year, its GRM is 10. A lower GRM means a higher return on investment and a shorter payback period. However, GRM does not account for operating expenses, vacancies, or financing costs, so it should be used with caution and in conjunction with other ratios.

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2 Net Operating Income

Net operating income (NOI) is a ratio that measures the amount of income a property generates after deducting all operating expenses, such as taxes, insurance, maintenance, and utilities. It is calculated by subtracting the total operating expenses from the gross income. For example, if a property has a gross income of $50,000 and operating expenses of $20,000, its NOI is $30,000. NOI reflects the cash flow and profitability of a property before debt service and taxes. A higher NOI means a more efficient and profitable property. NOI can also be used to calculate other ratios, such as cap rate and cash on cash return.

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Emilian Balan

Country Manager
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NOI is a good way to evaluate the performance, however it is not corelated with the initial investment, so that it cannot give an image of the efficiency of capital invested.

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3 Capitalization Rate

Capitalization rate (cap rate) is a ratio that measures the annual return on investment of a property based on its market value and NOI. It is calculated by dividing the NOI by the property's market value. For example, if a property has a NOI of $30,000 and a market value of $500,000, its cap rate is 6%. A higher cap rate means a higher return on investment and a lower property value. Cap rate is often used to compare the performance of different properties and markets. However, cap rate does not account for financing costs, appreciation, or depreciation, so it should be used with caution and in conjunction with other ratios.

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Syed I.

Strategic and Analytically driven Finance Professional
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Capitalization Rate (Cap Rate) is a crucial financial ratio for evaluating property performance. A higher Cap Rate indicates potentially higher returns and greater risk. Additionally, the Debt Service Coverage Ratio (DSCR) assesses a property's ability to cover debt payments, with a ratio above 1 indicating healthy cash flow. The Gross Rent Multiplier (GRM) helps assess the property's affordability and is calculated by dividing the property's price by its gross rental income. A lower GRM is generally favorable. Overall, these ratios provide insights into income generation, operating efficiency, and financial viability, aiding investors in making informed decisions about property investments.

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Tam Bui

Property Manager
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Cap rate arguably one of the best methods to evaluate property performance. As it helps investors quickly assess the potential return on an investment property, especially when comparing multiple properties or making initial assessments about potential acquisitions.

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Emilian Balan

Country Manager
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Cap rate is specific to each market, it 's rather a method to find out the market value of a property, not a method to determine the performance of the asset.

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4 Cash on Cash Return

Cash on cash return (CoC) is a ratio that measures the annual return on investment of a property based on its cash flow and initial investment. It is calculated by dividing the annual cash flow by the initial investment. The annual cash flow is the NOI minus the debt service (mortgage payments). The initial investment is the down payment plus any closing costs or renovation costs. For example, if a property has a NOI of $30,000, a debt service of $15,000, and an initial investment of $100,000, its CoC is 15%. A higher CoC means a higher return on investment and a shorter payback period. CoC is often used to evaluate the leverage and cash flow of a property.

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Omar Sarfraz, MBA

at PwC | Real Estate Strategy & Deal Advisory | Value Creation for High-Impact Real Estate Projects
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Cash on Cash Return is a simple, yet effective ratio which can be used to evaluate performance of a real estate asset. It is easy to understand by Investors as it exactly provides "the annual return on the actual cash invested in the project". The Investors are thus able to understand how much cashflow a real estate asset has generated relative to the amount of cash Invested initially.

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Emilian Balan

Country Manager
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From investor's perspective this is best method to assess the performance of an asset. Cash is a fundamental value which drives most of the investments. CoC gives a comprehensive picture of the efficiency of the capital invested.

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Syed I.

Strategic and Analytically driven Finance Professional
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Cash on Cash Return (CoC) is a crucial financial ratio for evaluating property performance. It assesses the cash generated relative to the initial investment. Net Operating Income (NOI) is vital, representing income minus operating expenses. A higher Cap Rate suggests greater profitability. Loan-to-Value Ratio (LTV) is crucial, expressing the mortgage amount as a percentage of the property value. A lower LTV implies less financial risk. Furthermore, Debt Service Coverage Ratio (DSCR) assesses a property's ability to cover debt payments, with a ratio above 1 signaling financial stability. These ratios collectively provide a comprehensive view of a property's financial health and suitability for investment.

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5 Debt Service Coverage Ratio

Debt service coverage ratio (DSCR) is a ratio that measures the ability of a property to cover its debt obligations. It is calculated by dividing the NOI by the debt service. For example, if a property has a NOI of $30,000 and a debt service of $15,000, its DSCR is 2. A higher DSCR means a more comfortable and secure debt position. A DSCR of 1 means that the property is breaking even, and a DSCR of less than 1 means that the property is not generating enough income to cover its debt. Lenders usually require a minimum DSCR of 1.2 to 1.4 to approve a loan.

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Vlad Vassilyev

Sr. Analyst at Accenture | Dynamic Finance Professional | CFA Level 3 Candidate
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A very important ratio. It is a little similar to cash on cash return, but places more focus on how well the property covers financing cost, it is the lens through which your lender is looking at your property through. As the lender is a major stakeholder in most real estate transactions, it is important to keep an eye on DSCR.

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6 Equity Build-Up Rate

Equity build-up rate (EBR) is a ratio that measures the annual increase in the owner's equity of a property. It is calculated by dividing the annual principal reduction by the initial investment. The annual principal reduction is the amount of debt that is paid off each year. The initial investment is the same as in the CoC calculation. For example, if a property has an initial investment of $100,000 and an annual principal reduction of $5,000, its EBR is 5%. A higher EBR means a faster accumulation of equity and wealth. EBR is often used to evaluate the long-term potential and appreciation of a property.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Nacho Pinazo Moreno

Real Estate/ Debt servicing
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Los mejores ratios para evaluar el rendimiento de una buena gestión de la propiedad son una buena performance en ventas, en recuperación de posesión y en la judicialización de carteras de deuda. En la gestión de propiedades inmobiliarias hay que tener en cuenta el flujo del proceso de gestión de activos y que los tenedores obtienen su máxima rentabilidad en la fase de conversión a REO para posteriormente poder comercializarlos libremente en régimen de alquiler o venta. La máxima rentabilidad del activo adjudicado (Real Estate Owned) se obtiene cuando: - está libre de cargas (fiscales y registrales) - se conoce su situación ocupacional y posesoria. - no existen trabas que dificulten su puesta en comercialización.

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What are the best financial ratios to use for evaluating property performance?

1

2

3

4

5

6

7

1 Gross Rent Multiplier

2 Net Operating Income

3 Capitalization Rate

4 Cash on Cash Return

5 Debt Service Coverage Ratio

6 Equity Build-Up Rate

7 Here’s what else to consider

Property Management

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What are the best financial ratios to use for evaluating property performance?

1

2

3

4

5

6

7

1 Gross Rent Multiplier

2 Net Operating Income

3 Capitalization Rate

4 Cash on Cash Return

5 Debt Service Coverage Ratio

6 Equity Build-Up Rate

7 Here’s what else to consider

Property Management

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