Cap rate, cash on cash return, and cash flow – these are some of the most important metrics used in the real estate investment business to assess and analyze investment properties to determine the best opportunities for profit.
What are those metrics, and how can you evaluate an investment property based on them? Are there any tools that exist to make it easier for real estate investors to use these metrics to come up with the best investment plans and strategies? This blog will answer these real estate questions and provide you with more information about Mashvisor, an all-purpose digital workbench for all of your real estate investment needs, allowing real estate investors to make their investments more seamless and easier than ever before.
What Are the Main Investment Property Valuation Metrics?
Unlike the stock market, the real estate market is less volatile, which generally makes it easier to assess and predict. While in most cases this can be true, it doesn’t mean that there aren’t several factors that can affect the real estate market both directly and indirectly. Nonetheless, real estate investors and experts have found a number of different ways to calculate estimates and project an investment property’s profitability and value compared to its level of risk, allowing investors with sufficient understanding of these evaluation metrics to become more capable of assessing their investments before they commit to them in order to reach their desired level of risk-to-profit.
The main metrics that are used by real estate investors to assess an investment property are as follows:
Cash flow is a real estate value that applies to income or rental properties. The simplest way to describe a rental property’s cash flow is that it is the rental income that the property generates through its monthly rent minus all expenses that apply to that rental property.
While cash flow is, in theory, a very simple metric to calculate, in reality, it can be more complicated than that. This is due to cash flow being very reliant on the calculation of all expenses that apply to the income property, including tax payments, insurance fees, water and electricity bills, loan payments and interest, and any other services or costs that a real estate investor would have to pay in order to run an investment property.
This also includes the expense of vacancy, or the loss of income that incurs whenever the rental property is vacant, which can also be tricky to calculate due to the need to gather a large amount of data on the rental property, its surrounding area, and other similar properties in the area in order to determine the estimated occupancyas well as vacancy rate on the property.
Cap rate is the main metric used by most real estate investors to determine the profitability of an investment property. In simple words, the cap rate is a metric that measures the return on investment of an investment property by dividing the property’s Net Operating Income (NOI), which is typically equal to its cash flow, by the cost or value of the property.
Basically, if a property’s value is $1,000,000, and its annual NOI is $100,000, then its cap rate would be 10%. This gives the real estate investor an idea of what return on investment to expect from an investment property if he/she was to buy the property in cash.
Cash on Cash Return
The only downside to using cap rate as a valuation method for an investment property is that it assumes that you’re going to pay for the property in cash. But most real estate investments are made using borrowed money, and cap rate does not take that into account. And while cap rate can determine the overall value of an investment regardless of your financing method, the cash on cash return in the metric that you will want to use to determine an investment property’s profitability based on your method of financing.
In order to calculate a property’s CoC, you should divide the property’s NOI by the amount of cash that you’re using out of your own pocket to purchase the property.
Example: If a property is worth $1,000,000, and you’re paying 30% of its value in cash ($300,000), and that property is generating NOI of $10,000, then its CoC would be 3%.
Related: Cap Rate vs. Cash on Cash Return
How to Decide on an Investment Based on These Metrics
While these metrics can help you get an idea of the projected earnings of an investment property, there are usually several other factors in the real estate market that determine the average rate or value of each metric that is considered to be acceptable or effective for a real estate investment.
The cap rate on an investment property, for example, can be used to determine the level of risk associated with the property. Higher cap rates typically indicate a higher level of risk, while lower cap rates indicate lower risks. Based on the housing market that you’re investing in and on your own projections of that market and its future development, you should be able to decide the cap rate that suits you best in the market based on your acceptable level of risk.
Mashvisor: A Shortcut to Success
While this might all seem too complicated and requiring a lot of time and effort to gather all the data needed to calculate and analyze different investment properties and compare them, there is a platform that is available to real estate investors to make the process easier and more seamless than ever before.
Mashvisor is a platform designed for real estate investors to make their search for investment properties easier by providing them with tools such as:
The Mashvisor property finder tool allows real estate investors to find investment properties based on their preferences of the metrics mentioned above. If an investor is looking for investment opportunities with certain values for the different metrics – investment properties with a minimum cap rate of 5% for example- he/she can easily set the search criteria to filter out any properties that fall below that cap rate, allowing him/her to easily identify the properties that meet his/her investment preferences.
Using the heat map function, real estate investors are able to easily find the best neighborhoods and areas that are performing well based on their metric of choice. Setting the heat map for cap rate, for example, allows a real estate investor to get a quick view with visual cues of a neighborhood or a city, and enables him/her to quickly determine the best areas to target for a real estate investment.
In addition to finding investment properties based on their search criteria, real estate investors now have a quick way to access analytics related to their property or neighborhood of choice. These analytics are completed with historical and comparative qualitative and quantitative data in order to help real estate investors build an investment strategy that is specifically designed to target the property or neighborhood of their choice, as well as being more able to forecast the return on investment of the real estate property that they are considering.
Real estate investing involves plenty of numbers, calculations, data analysis, and comparisons. While gaining an understanding of the different metrics and their calculation methods can enable real estate investors to assess and analyze their investments on their own, the process can often be time-consuming and daunting, causing many real estate investors to give up on their ventures due to their inability to invest the required amount of effort to achieve success on their investments.
Mashvisor, however, made it easier than ever before for real estate investors to get into the real estate market and compete in it. Investors who use Mashvisor, in fact, have an upper hand when it comes to time and effort investment, giving them an advantage over their competition, and allowing beginner real estate investors to compete on equal grounds with experts with multiple years of experience in the real estate market.