When investors evaluate potential investment property deals, they get down to the numbers and the ratios to determine their profitability. Oftentimes, besides the qualitative reasons, it is the numbers that back most of their investment decisions.

In this article, we are gonna talk about 5 top investment ratios every property investor should know. LET’S DIVE IN.

1. Cap Rate

Why this ratio: Cap Rate is the rate of return on a property based on the annual income that the property is expected to generate. Investors compare cap rates of different properties to evaluate their potential return and risks. Generally, higher the cap rates, greater the return and the risk. 

According to CoStar & JP Morgan, here are some examples of cap rates in different areas in the United States: 

As you can refer to the above data, bigger and metro-level cities such as San Francisco and New York normally see cap rates in the 3.8%-5.5% range for apartments. 

Good Range: 4%-12% depending on the location & the type of the property. 

2. Cash on Cash Return (COC)

Why this ratio: Different from cap rate, COC takes into account the financing method – if you have taken out a loan, you subtract the annual debt service from NOI before arriving at the annual pre-tax cash flow.

This ratio is especially useful for investors who value cash flow; investors can decide on the best cash-producing property by comparing COCs among different leads. 

Good Range: 8%-15% depending on investment strategy

3. Internal Rate of Return (IRR)

Formula: 

Why this ratio: IRR measures the profitability of a potential investment taking into account the time value of money; it tells about the annual growth rates of an investment over the holding period. 

Another similar ratio you might have heard is called ROI (Return on Investment) and it is calculated by:

ROI = (Current Value – Original Value)/ Original Value)

But ROI does not consider the time value of money like IRR does, therefore IRR might give a better picture of how the property profits for the given period of time.

Good Range: 10%-25% depending on the property type & the holding period etc.

4. Rent to Value 

Why this ratio: rental income is one of the most common passive income that real estate investors can earn. Therefore, generally speaking, the higher the rent-to-value ratio, the better the deals. 

If you are a cash flow person, you would be familiar with the 1% (and 2%) Rule, which states the monthly rent of an investment property should be equal to or no less than 1% (and 2%) of the purchase price. 

Good Range: equal to or more than 1%

5. Break Even Ratio (BER)

Why this ratio: BER tells you the minimum occupancy needed to cover all operating expenses and mortgage payments for a rental property.

By comparing the property’s BER and that of similar properties in the market, one can tell whether it is a good or risky investment opportunity. 

Good Range: lower than the local market’s average occupancy rate

Summary

In addition to the ratios mentioned above, there are also other ratios that can inform investors of their deals: Return on Equity (ROE), Gross Rent Multiplier (GRM) and Equity Multiple (EM) etc. 

Luckily, there is an easy way to calculate all of these ratios in one place: DealCheck, which I personally use for calculating financial ratios and evaluating potential deals – hands down, one of my favorite deal analysis websites of all time. 

Use the promo code PASSIONATE for 20% off when you purchase any products on DealCheck! Sign-up link here. 

With DealCheck, you can view your property analysis and financial ratios in one place: 

All these investment ratios tell different sides of the property deal. Depending on your investment strategy, you can compare the ratios among different properties and decide on which is your best bet. 

In addition, remember, these financial ratios can be influenced by various factors including location, property type, interest rates, holding period and market inventory etc.

When comparing a ratio among different properties, we shall also try to hold the other assumptions the same. That way, we can arrive at a well-supported conclusion that powers our investment decisions. 

Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational and entertainment purposes only. Read our full disclaimer here.