Peter Drucker was often quoted saying “You can't manage what you can't measure.” This oversimplification might ignore some of the complexities of relationships in business, but it is very telling. Being able to measure what matters is important to business.
What is a KPI?
A KPI is a Key Performance Indicator. That means it is a metric that can give you an insight into how your business is performing.
Usually KPI's are tracked over specific intervals of time, such as daily, weekly, or monthly. This helps show the trends in the numbers and will help identify business practices that are working and business practices that are failing.
How do you use KPI's?
One of the important aspects of using KPI's is knowing when to focus on improving and monitoring what KPI. Since it will take effort to get accurate data and calculate some of these KPI's, it is important to focus on KPI's that are actionable.
Because every real estate investor's business model is different, there will be different opportunities by focusing on different KPI's. Depending on where your business is in it's lifecycle will also determine which KPI's are the most important to focus on. If your business is in an expansion state, the acquisition KPI's may be the most important ones to focus on. The property management and overall KPI's may be the best to focus on when you are not focused on expanding your portfolio.
- You can use KPI's to help identify and fix what is broken.
- You can also use KPI's to focus in and crush it with what is working.
- You can also use KPI's to alert you when something is drifting out of place.
These overall KPI's shed light into the whole real estate investment business. They are also important to understand since they are very relevant for bankers considering issuing a loan.
While they are very important, many of these are trailing indicators of performance. So often when there are changes in performance of the overall KPI's, it indicates that there is a problem in business practices that started months or even years ago.
Cashflow is one of the most important KPI's in any business. It can literally mean the difference between success and failure of your investments.
The definition of cashflow is the income left after expenses. Depending on who the audience is for the Cashflow metric, you may or may not include the Capital Expenditure Reserves in this calculation. You do not subtract out depriciation.
Cashflow = Gross Income - Operating Expenses for Property - Capex Reserves - Debt Service
If you are calculating potential cashflow of a property here is an example formula of pro forma cashflow.
Pro Forma Cashflow = Gross Potential Rent - Vacancy Allowance - Management Fees - Property Taxes - Property Insurance - Property Maintainance - Capital Expenditures Allowance - Debt Service
Net Operating Income (NOI)
The net operating income is similar to cashflow except that it does not include debt service. It also does not include savings in capital expenditure reserve accounts. The purpose of NOI is to show how a property performs independent from it's capital structure.
NOI = Gross Income - Operating Expenses for Property
The textbook definition of NOI does not include deductions for capital reserve accounts. If you are using the NOI for internal metrics, it might be wise to include capital reserve accounts in your calculations. Technically at that point you are not really using a true NOI figure though.
Pro Forma Cashflow = Market Rent - Vacancy Allowance - Management Fees - Property Taxes - Property Insurance - Property Maintainance
It is hard to talk about real estate investing without discussing Cap Rate or Capitalization Rate. The Cap Rate is the rate of return for all capital in a project. It is useful when comparing one property to another, comparing markets, and estimating values of assets.
Cap Rate = Net Operating Income / Property Value or Cost
One very useful tool is using the cap rate to determine how much you can increase the value with forced appreciation by increasing the Net Operating Income.
Debt Service Coverage Ratio (DSCR)
DSCR is a favorite metric of bankers as it is a ratio that determines how much room there is in the income of a property to pay them. The higher the DSCR, the more cash the asset is generating, which makes it a safer investment for the banker.
The DSCR can be calculated globally for all of a borrowers assets, or it can be calculated on the subject property itself. Usually bankers will have requirements for both the borrowers global DSCR, and for the DSCR of the specific property.
DSCR = Net Operating Income / Annual Debt Service
Loan to Value (LTV)
Another term you will want to be familiar with before talking with bankers is Loan to Value. Bankers use this to determine how at risk their principal is in the unfortunate scenario of default. LTV is the ratio of the loan amount to the property value. As the loan amount goes up, the ratio goes up, so does the risk.
The higher the LTV the higher the risk. The higher the risk, the higher the interest rate
Loan to Value = Loan Amount / Appraised Property Value
One caviot is that if a lender says they will lend up to 80% LTV, they typically will not lend over 80% of the purchase price. So for the Appraised Property Value in the formula, they will use the lower of the property value and contracted purchase price.
Cash on Cash Return (CoC)
Cash on cash return is extremely important to most individual investors. It is the rate of return on the actual cash invested in the property. It is useful to compare prospective investments to one another, and to compare real estate investments to other vehicles.
Calculating the Cash on Cash return of an existing investment is very useful in benchmarking where you are in performance to the pro forma estimates. It is also a useful calculation for your overall portfolio.
Cash on Cash Return = Cashflow / Total Cash Investment
One of my favorite ways to look at Cash on Cash return is by segmenting the portfolio. For instance, comparing all the single family assets to multi family assets Cash on Cash return in a portfolio. Another way to segment is by segmenting zipcodes, asset classes, and business models. For segmenting out business models you could segment on things like how distressed the property was at acquisition.
Return on Equity (Cash on Equity)
One of my favorite metrics to track on a portfolio over time is Return on Equity. As a property appreciates, and debt paydown occurs, net wealth increases. This is great, but with it, the total return on equity or return on net wealth decreases.
Your money becomes fat and lazy.
To combat your money becoming fat and lazy, you can refinance the property to decrease the amount of equity in the property. Another option is to sell the property and use the increased equity to buy a larger property with larger cashflows.
The argument against a cash out refinance or sale and purchasing another property is that they both increase your leverage. This makes the investments at a higher risk of default. Usually the objective is returning the property to the original LTV using the new appraised value. Saying this is risky is also saying that the LTV of the original investment was risky.
Return on Equity = (Cashflow + Incre ase in Equity for Current Period ) / Current Equity
The Current Equity is defined as current estimated market value minus outstanding debt.
Most of the KPI's and metrics used in acquisitions behave in a funnel. Tracking the raw numbers over time can be helpful. Perhaps it is more insightful to track the relationship between each of these over time.
For instance, if you have had a ratio of properties walked to offers made of around 4:1 or 25% each month for the last year and then suddenly it drops to 8:1 or 12%, then that is something worth looking into.
The number of leads that came in during a specific period. These can be segmented by lead source and type of leads to provide more granularity into your business. This is the top part of your sales funnel, so keeping track of its health is important.
Most real estate investors track leads for both properties and for potential investors.
The number of properties and deals reviewed in a month. This is near the top of the funnel. There will be some loss between the total number of leads and actual deals.
The next stage in the funnel is actually getting out and walking the property. Since many deals will not meet basic criteria, they will get to this stage.
Walking a property is costly as it takes significantly more time than running a few data points through a screening sheet on excel. If you are investing in a large geographic area these can go up exponentially.
This is a count of offers made during that period. Generally there is a lot of effort that goes into writing a competitive offer. One segment that I like to track in this category is competitive offers vs lowball offers.
One strategy for not wasting time working on a competitive offer after an underwhelming walk of the property is to submit a lowball offer. Lets say it is a single family property and after walking it you realize that even though on the high level it is very similar to the comps, it will just be missing a little something that makes achieving the projected ARV a bit risky. Rather than spending a bunch of time on a potentially dead end of being able to offer 70 or 80% of the ARV, offering 50-60% of the ARV and moving on can be a good strategy.
Near the end of the acquisitions funnel is the Offers accepted metric. There is still the potential for a property to not make it through the whole contract phase.
This is the last stage of the acquisitions funnel.
You can track the total number of completed purchases, the number of units purchased, and the dollar amount of the purchase. The number of units purchased and the dollar amounts will show a better picture of how strong the business has been over time than simply the number of completed deals. Comparing the number of completed deals over time will show the strength of the acquisitions funnel.
Projected net casfhlow purchased
The final measure to how well the acquisitions funnel is working is the projected profit from the deals acquired.
This data will be very helpful in the future in determining how the asset performed vs its projected performance. You should be able to use this data to adjust your expectations in the future, and you can use this to identify any missmanagement issues.
Property management KPI's
Properly executing property managent can make or break your investment strategy. It is important to keep a close eye on the key metrics of property management to make sure things are not slipping away from you.
Poor management usually shows itself over the course of time rather than all at once. That is why it is good to monitor factors that can be leading indicators of poor management.
Gross Potential Rent (GPR)
The Gross Potential Rent is the total market rent of a property if every unit were fully occupied. It is the top line of the income statement of a rental property.
Gross Potential Rent = Market rent x Number of Units
Sometimes this is reffered to as Gross Scheduled Rent.
Gross Potential Income (GPI)
Gross Potential Income is often the same as Gross Potential Rent. The difference is, it accounts for income from other sources like parking space fees, laundry, and any other ancilary income streams from the property.
Gross Potential Income = Gross Potential Rent + Other Sources of Income
Vacancy Rate is the percentage of units that have gone unocupied over a period. When compared to other properties in the same market, it is a very good indicator of how well managed a property is.
When comparing one market to another, vacancy rate is one of the factors that you can use to evaluate strength of the market.
Changes in vacancy rate inside your portfolio should be looked at very closely. If the vacancy rate of your portfolio is rising, it is important to figure out why and try to correct it. Increases in vacancy rate will soon have a major impact on your bottom line.
Vacancy Rate = Number of Units Vacant / Total Units
Gross Operating Income (GOI)
Gross Operating Income is essentially the actual amount collected from the Gross Potential Income. In accordance to Generally Accepted Accounting Principles (GAAP), the way to book rental income is to start with the potential and then deduct the amount not collected through vacancy.
Gross Operating Income = Gross Potential Income - Vacancy and Credit Loss
Another way to think of Gross Operating Income is as the total cash collected from the property.
The Average Arrears can be tracked in both days of arrears or the number of units in arrears compared to total units.
Average Arrears = Number of units late on rent / Total units
Tenant Turnover is the rate that each unit is turned over from one tenant to another. Since turnovers incur costs such as vacancy, making the unit rent ready, and advertising costs, keeping the tenant turnover low can be a big cost savings.
The higher your rent compared to market rent, the more pressure your property will have towards tenant turnover. When determining a pricing strategy it is important to consider how increasing the rent can increase tenant turnover expenses and potentially lead to lower net income.
Tenant Turnover = Units Turned over / Total Units
Rent Ready Costs
Rent Ready Costs are the costs incurred during a tenant turnover to make a unit rent ready again. These typically can include carpet, paint, and cosmetic repairs.
Rent Ready Costs = Total costs spent on a unit between tenants
Average Days to Lease is the count of how many days from when a unit becomes vacant to when it is leased back up again.
This metric contains both the amount of time it takes to turn a unit and the amount of time it takes to market the unit until it is leased.
Average Days-to-lease = Sum of Days from Vacancy to Lease / Number of Vacancies
Keep a watchful eye on the Average Days-to-Lease. If the number starts slipping, it is an indicator that the property is not being well managed. Miss-management will often show up in this metric before it shows up on the bottom line.
Repair and Maintenance Costs
The Repairs and Maintanance Costs are the expenses
occured keeping the property up to date. This is things like repairing a roof, repairing HVAC system, etc. It does not include the larger capital expenditures like a new roof.
Keeping an eye on these costs can help indicate if there are underlying problems with the way the property is being managed.
Repair and Maintanance Costs = Total spent on maintainance
Property Management Fees
The Property Management Fees are the fees charged by a property management company to maintain the property, manage the leases, collect rent, and lease vacant units.
There are a few different ways which property management is billed, and that will be covered in the contract with the property management company. Some contracts include a fee for placing a new tenant, some charge a percent of rent collected, some charge flat fees.
Property Management Fees = Total fees charged by property managment
Just about any residential real estate management will involve construction at one point or another. It may be construction planned for just after acqusition, or could be renovations after years of ownership.
These KPI's can be used to monitor new construction, complete remodels, and capital expenditure projects.
Budgeted construction costs
Budgeted Construction Costs are the anticipated costs for a construction budget.
Creating an accurate budget is one of the most crucial steps in construction. To get an accurate budget, it will be a combination of bids from contractors and estimates on materials and other labor and expenses blended together.
Budgeted Construction Costs = Estimated value to be spent directly on construction
Actual Construction Costs
The Actual Construction Costs are the total spent directly on the project. It is important to keep up to date figures on where you stand with a project.
Actual Construction Costs = Total directly spent on construction
Construction Budget Variance
The Construction Budget Variance is the difference between expected budget and current amount spent on completed line items in the budget.
Knowing if the project is going over budget early on can help in being able to make decisions later in the project that can save money and get the project back on budget.
The Construction Budget Variance is one of the most important metrics to track for construction. Being over budget eats directly into the bottom line of a project.
Construction Variance = Budgeted Construction Costs - Actual Construction Costs
Days Ahead (Behind) on Progress
This is the variance between anticipated schedule to where construction actually is at a point in time of the project.
Just as important to the construction process as budget is schedule. Being behind on schedule will lead to escalating holding costs and will ultimately lower the chances of success of the project.
Days Ahead (Behind) on Progress = Date - Projected Date of Current Milestone
The last stage of the lifecycle of property ownership is disposition. These KPI's will help monitor the overall health of the disposition process.
Days on Market
Days on Market measures the length of time a property is for sale before it goes pending.
Tracking average days on market is useful for determining the health of a particular market. Markets with lower days on market are typically more of a sellers market than ones with higher days on market.
When looking at days on market of your own properties, it can be used to give some insight into how the market percieves your product in compison to the rest on the market.
Days on Market = Date Pending - Listing Date
Sale Price to List Price
Sale Price to List Price is pretty much exactly what it sounds like. It is the difference between the two prices.
Looking at the typical Sale Price to List Price over time in a specific market is a good way to get a feel for the strength of the market in that particular time.
Comparing the difference between sale and list price to the market in general can be helpful in showing how your marketing is doing in comparison to the rest of the market.
Sale to List Price = Sale Price - List Price
Value under contract
The value under contract is the dollar amount of all properties under contract.
This can be a useful metric as your volume scales. It can give you a picture into growth of your operation.
Value Under Contract = Sum(Sale Price AllProperties Under Contract)
This is similar to Value Under Contract except it is the projected profit of properties under contract.
This metric gets important towards the end of the year for tax planning.
Projected Profit = Sum(Sale Price - All in Property Expenses)
This is similar to Value Under Contract except it is the projected cashflow of all properties under contract.
This metric is useful when trying to project future cashflows and plan out further acquisitions.
Projected Cashflow = Sum(Sale Price - Outsanding mortgages - Property Tax Propration - Transaction Costs)