Below are some common terms that you will see when analyzing one our projects:
Capitalization Rate (Cap Rate) – A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor’s potential return on his or her investment. This is done by dividing the income the property will generate (after fixed costs and variable costs) by the total value of the property.
When acquiring income property, the higher the capitalization rate (“Cap Rate”), the better.
When selling income property, the lower the Cap Rate the better.
A higher cap rate implies a lower price, a lower cap rate implies a higher price.
Cash Flow – Cash generated from the operations of a company, generally defined as revenues less all operating expenses.
Cash-on-Cash – A rate of return often used in real estate transactions. The calculation determines the cash income on the cash invested.
Calculated: Annual Dollar Income Return / Total Equity Invested = Cash-on-Cash
Debt Service Coverage Ratio (DSCR) – It is the multiples of cash flow available to meet annual interest and principal payments on debt. This ratio should ideally be over 1. That would mean the property is generating enough income to pay its debt obligations.
Investor Average Annual Return, excluding disposition – The average return per year during the investment hold. This calculation does not include the return of invested capital.
Investor Average Annual Return, including disposition – The average return per year including profits from disposition.
Internal Rate of Return (IRR) – The rate of return that would make the present value of future cash flows plus the final market value of an investment opportunity equal the current market price of the investment or opportunity. The higher a project’s internal rate of return, the more desirable it is to undertake the project.
Return on Equity (ROE) – The amount of net income returned as a percentage of shareholders equity.
ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder’s Equity