A key part of running a successful property management company or maintaining a profitable real estate portfolio is monitoring property performance. Regularly reviewing how each individual asset is performing is helpful in determining what risks are present and what opportunities exist to improve the return on investment (ROI) and ultimately increase the property's cash flow.
Knowing how to review and assess a property's performance can help you identify if the property is operating at below-market rental rates, is losing income due to high vacancy rates and slow turn over time, or if certain expenses can be reduced.
Whether you own and manage your own real estate investments or you manage rental property for others, here are five ways to measure property performance.
Net cash flow
The starting point for most income-producing properties is determining the net cash flow of the investment. A property manager or owner should have detailed records of a property's rental income and expenses showing how much money has come in and gone out as well as where the money is coming from and going to. Most professional property management software programs can help produce an income and expense report for each investment property, which ideally is the trailing 12-month period.
Calculate the gross income for the year subtracting the total expenses for the property, which provides the net operating income (NOI). If you have a mortgage or investor partners on the property, deduct your debt service payment to get your net cash flow of the property.
The net cash flow is helpful in determining if the risk is worth the reward in a particular investment. For example, if you own a property that only produces a net cash flow per door of $50, it may not be worth your investment for the risk you take on by owning that particular property. However, if you're making a net cash flow of $200 per door for that same property, the risk may be worth the reward. There is no perfect number to reach here, but understanding how much cash flow an investment property produces for you net pre-tax, can help you determine if owning the property is worth it or not for your particular financial goals.
Cash-on-cash return (CoC) is a very helpful tool to see how an investment is performing in real-time and can be easily compared to other income properties to see if your property is matching, beating, or below current market CoC performance.
Cash on cash is calculated by taking the net cash flow of the property and dividing it by your initial investment. For example, if the property produces $5,000 a year, and you originally invested $40,000 as a downpayment, you are earning a CoC return of 12.5% in the given 12- month period. CoC can change each year, especially if you experience tenant turnover or vacancy, so it's up to the investor and property owner to determine if their CoC is reaching, exceeding, or falling short of their goals.
Vacancies kill profits. Most asset classes in commercial real estate and residential will have an average economic vacancy rate, which is an average percentage rate similar properties have in the current market for vacancies. The goal is to match the current economic vacancy rate. Being at 100% capacity may look good on paper, but most of the time it means you're charging below-market rents. Raising rents will increase vacancy but almost always means you'll increase your net cash flow. Conversely, if you notice you have a higher vacancy rate than the market average, you may have your units priced too high and are being beat by the competition.
While most investments in real estate are purchased for income, there are times that holding a real estate investment makes sense because of capital appreciation. If the property is appreciating steadily over time but produces limited cash flow, it may be worth the risk of holding because of its value in the marketplace. Look at the market's current appreciation rate and make sure it's at least keeping up with the national average. Ideally, you want an appreciation rate that matches or beats this number.
An investment audit is a thorough review and analysis of an investment that can be done by the property owner or by a third-party asset management company. The analysis typically includes reviewing rental rates and expenses comparing them to current market averages to identify areas where the property owner is overpaying or undercharging rent.
It also looks at various market factors, such as real estate appreciation, job growth, economic activity, and new construction to determine vulnerabilities in the marketplace and suggest reserve increases to hedge against certain risks. It can also identify if there are weak areas in the management of the property. Maybe tenant turnovers are taking too long and are eating away at profits or money is being reported incorrectly by the manager. The investment audit uses the net cash flow, economic vacancy, cap rate or market value, and cash-on-cash return comparing it to other similar properties to see how it's performing with the competition.
Investors can use the measurement methods above to help compare their property performance, making improvements in the necessary areas to maximize returns, but ultimately determining if a property is performing well or not is up to the investor. Comparing metrics for your individual investment can be helpful to gauge performance, but really it comes down to if it's meeting your personal financial goals and is worth the risk.