Topic 06 · 6 min read
The Numbers That Matter
Four figures that tell you whether a deal is a deal.
Investors compare properties with a handful of simple ratios. Net operating income is rent minus operating costs. Cap rate is that income divided by the price. Cash-on-cash return compares the yearly cash in your pocket with the cash you put in. Debt coverage compares income with the loan payment.
What to know
- Net operating income
- The building's own earnings, before any loan. It is the fairest way to compare two properties bought different ways.
- Cap rate
- Income divided by price. A higher cap rate usually means a cheaper price relative to income — and often more risk.
- Cash-on-cash return
- Yearly cash flow divided by the cash you actually invested. It answers what your money is earning.
- Debt coverage
- Income divided by the loan payment. Below about 1.2 and there is no room for a bad month.
The tax benefit
None of these ratios are tax figures, but they set the ceiling on what any tax strategy can be worth — a weak deal stays weak after deductions.
Worked example
Comparing two buildings
A $300,000 building earning $21,000 has a 7 percent cap rate. A $400,000 building earning $22,000 has 5.5 percent. The first earns more per dollar; the second may sit in a stronger neighborhood.
Watch out for
- Sellers compute these with optimistic expenses; recompute them yourself.
- Cap rate ignores the loan entirely, so it says nothing about your cash flow.
- One great ratio cannot rescue three bad ones.
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