In brief · 200 word summary: The Metrics That Matter
Real estate deals are described with a handful of metrics, and understanding what each one does, and does not, tell you is how you read a projection critically. It starts with net operating income, the rental income a property produces minus its operating expenses before debt. NOI is the engine, and a business plan that grows it is what creates value. Cap rate is NOI divided by price, a snapshot of unleveraged yield that says nothing about financing or growth. Cash on cash is annual cash divided by cash invested, but ignores the eventual sale. Equity multiple is total dollars returned divided by dollars invested, but ignores time.
IRR is the annualized return that weighs the timing of every cash flow, and it is highly sensitive to the assumed exit, which is only a projection. DSCR is the cushion on the loan. No single metric decides a deal. A high projected IRR built on aggressive rent growth and a low exit cap rate can be weaker than a modest IRR built on conservative assumptions. The discipline is always to ask what the numbers assume, not just what they are, and to study the downside case.
The essentials
- NOI is net operating income: rental income minus operating expenses, before debt. It is the engine of value.
- Cap rate is NOI divided by price, a snapshot of unleveraged yield.
- Cash on cash is annual cash distributed divided by cash invested. Equity multiple is total dollars returned divided by dollars invested.
- IRR is the annualized return that accounts for the timing of every cash flow. DSCR is the margin of safety on the loan.
- No single metric decides a deal. Always ask what the numbers assume, not just what they are.
Section 01Start with NOI, the engine
Net operating income is the rental income a property produces minus its operating expenses, such as taxes, insurance, utilities, management, and repairs, before any mortgage payment. NOI is the number almost everything else is built on. A business plan that grows NOI, by raising rents, cutting waste, or improving occupancy, is what creates value. When you read a deal, understand how the sponsor plans to move NOI, and whether those assumptions are realistic.
Section 02The metrics, and what each one hides
| Metric | What it measures | What it hides |
|---|---|---|
| Cap rate | NOI divided by price. Unleveraged yield at a moment in time. | Nothing about financing, growth, or the business plan. |
| Cash on cash | Annual cash distributed divided by cash invested. | Ignores the eventual gain or loss on sale. |
| Equity multiple | Total dollars returned divided by dollars invested over the hold. | Ignores time. A 2x over three years and over ten years are very different. |
| IRR | The annualized return that weighs the timing of every cash flow. | Highly sensitive to exit assumptions, which are projections. |
| DSCR | NOI divided by debt payments. The cushion on the loan. | A thin DSCR means little room before the loan is under stress. |
Section 03How they fit together
Think of it as a chain. NOI drives value. Value at a given cap rate sets the price. Debt sits on top and determines DSCR and how much cash reaches equity, which drives cash on cash. Over the whole hold, the timing and size of every distribution and the eventual sale determine the equity multiple and the IRR. Change one assumption, such as the exit cap rate or rent growth, and the headline IRR can swing dramatically.
Section 04The questions to ask about any projection
- What rent growth is assumed each year, and is it above or below the market's history?
- What exit cap rate is used, and is it higher or lower than the entry cap rate? A lower exit cap rate flatters the return.
- What happens to the return in the downside case, with flat rents or a higher exit cap rate?
- How much of the projected return comes from operations versus the assumed sale price?
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