Best Metrics for Evaluating Rental Property Returns

When it comes to analyzing real estate investments, operators often focus on metrics like LTV or DSCR. However, there's another critical measure that lenders pay close attention to: Debt Yield. While DSCR assesses the property's ability to meet payments currently, Debt Yield evaluates the loan's safety for the future. The calculation is straightforward: Divide the Net Operating Income (NOI) by the Loan Amount. For instance, a $240,000 NOI on a $2.4 million loan results in a 10% debt yield. Different types of lenders have varying comfort levels with debt yield: - Banks typically seek 10% or higher - Agencies are content with 8-9% - Bridge or higher-risk lenders might accept 7% but charge higher rates to offset the risk The significance lies in how Debt Yield factors out variables like interest-only structures or projected rent increases, providing a clear picture of the cushion between NOI and the debt. During market fluctuations, this metric becomes even more crucial. What might suffice at 8% in a robust market could require 9-10% for refinancing in a tougher environment. For operators, the key points to remember are: - Understand your current stabilized debt yield - Stress-test it for potential decreases in NOI or higher cap rates - While DSCR may appear favorable, it's the debt yield that truly reassures lenders when market conditions change.

An investor told me he wasn’t interested in investing unless I could deliver a 20%+ IRR. A 20% IRR looks great on the cover of an offering memo, but to gain confidence that it is achievable, you have to understand the key inputs that drive it. 👉 Exit Cap Rate: It’s incredible the extent to which a mere 50 bps decrease in the exit cap rate can increase returns. Make sure the assumed exit cap is supported by recent trades (and no, “recent” does not include 2021 and 1H 2022 when money was free). 👉Rent growth: a shocking volume of operators today are assuming high single-digit rent growth 3-5 years out because of a predicted supply shortfall. 7% rent growth is great in an upside scenario, but there is no reason why base case underwriting should ever assume rent growth above historical trend. 👉R&M / CapEx: real estate assets require a lot of capital to maintain, especially those built pre-1980. I can tell you from experience that the standard $500/unit assumption will not cut it. Anything lower than $1,000/unit should be cause for concern, and in most cases, the true R&M / CapEx requirement will be significantly higher than that. 👉OpEx growth: I have yet to find a unicorn property for which expenses decrease annually. Ensure reasonable expense growth is baked into the underwriting, especially for taxes and insurance. Many operators fail to consider the likely increase in taxes resulting from a reassessment after sale. 👉Leverage: higher leverage = higher returns, but also higher risk. If things go south, there is simply less of a cushion. 👉Hold period: IRR is a great metric because it takes the time value of money into account. A shorter hold period will drive up IRR relative to a longer hold. With all of the above levers, the unfortunate truth for investors is that IRR is a very easy-to-manipulate metric. If you are only looking at deals that advertise a 20%+ IRR, you may be unintentionally indexing for an overly aggressive exit cap rate, unrealistic rent growth, a CapEx budget that is far too low, and maximum leverage. 

IRR vs. Equity Multiple: The Truth About Investment Metrics I see a lot of real estate investors debating which metric is better—IRR or Equity Multiple. Some argue that IRR can be manipulated, so Equity Multiple is the superior metric. Here’s my take: Equity Multiple is a great “summary” metric—it answers the question: Over the entire hold period, how much did my money grow? IRR is a great “efficiency” metric—it tells me: Over the entire hold period, how quickly did my money grow? Both metrics have their place, and both can be manipulated with aggressive assumptions. The real question isn’t which metric is better—it’s which one is more relevant to the decision you’re making. The same applies to other metrics. ➡️ Cap rate is useful for comparing stabilized assets but says little about leverage or growth. ➡️ Cash-on-cash return is great for income-focused investors but ignores appreciation. ➡️ Yield-on-cost helps assess value creation in development and value-add deals but becomes less relevant post-stabilization. Every metric has its appropriate and inappropriate use case—you just need to tailor it to the deal and the audience you’re presenting to. Talking to a lender? You better be ready to talk LTV/LTC, DSCR, Debt Yield, and Loan Constant as it relates to your project’s cash flows. At the end of the day, smart investors don’t rely on a single number. They look at the full picture. What’s your take? Do you lean more on IRR, Equity Multiple, or something else entirely?

I've underwritten over a thousand real estate deals over my career, here are the 2 biggest mistakes I see passive investors make when evaluating multifamily investments: #1 They fully trust sponsor numbers #2 They focus on returns without considering the risks Until they realize the deal isn't performing as promised and they get a capital call. Here's how to analyze properties like an experienced investor: 𝗦𝘁𝗲𝗽 𝟭: 𝗟𝗼𝗼𝗸 𝗮𝘁 𝘁𝗵𝗲 𝗜𝗥𝗥 IRR is your most important return metric. It factors in the time value of money. If sponsors only show average annual rate of return ("AAR") instead of IRR, that's a red flag. Always ask for it. Value-add deals typically present 15%-17% IRR. ___ 𝗦𝘁𝗲𝗽 𝟮: 𝗣𝗮𝘆 𝗮𝘁𝘁𝗲𝗻𝘁𝗶𝗼𝗻 𝘁𝗼 𝗬𝗲𝗮𝗿 𝟭 𝗚𝗣𝗥 This single factor impacts IRR more than anything else. Some deals assume 100% of units hit post-renovation rents on day one. Completely unrealistic. Red flag: If sponsors assume >3% rent growth in year one based on recent growth numbers, they're being aggressive. __ 𝗦𝘁𝗲𝗽 𝟯: 𝗖𝗵𝗲𝗰𝗸 𝘁𝗵𝗲 𝗘𝘅𝗶𝘁 𝗖𝗮𝗽 𝗥𝗮𝘁𝗲 This determines your resale value and is the #2 factor impacting IRR the most. Many deals assume cap rates compress by 50+ basis points after 5 years. That's aggressive. Compare their assumptions to long-term market trends and historical data. __ 𝗦𝘁𝗲𝗽 𝟰: 𝗦𝘁𝗿𝗲𝘀𝘀 𝗧𝗲𝘀𝘁 𝗥𝗲𝗻𝘁 𝗣𝗿𝗼𝗷𝗲𝗰𝘁𝗶𝗼𝗻𝘀 Every deal assumes rent increases after renovations. But can people actually afford them? Compare proforma monthly rents to 30% of monthly median household income. If higher, leasing will be difficult. Also check: Population growth + job growth = future rent support. __ 𝗦𝘁𝗲𝗽 𝟱: 𝗘𝘃𝗮𝗹𝘂𝗮𝘁𝗲 𝗥𝗶𝘀𝗸 Don't chase high returns without understanding the risks. Check: - Market conditions (new supply, historical and current submarket occupancy, diversity of employers) - Type of debt - Exit assumptions - Reserves collected for unexpected expenses or drop in occupancy Ask sponsors for stress test scenarios. __ 𝗦𝘁𝗲𝗽 𝟲: 𝗞𝗻𝗼𝘄 𝗪𝗵𝗼'𝘀 𝗠𝗮𝗻𝗮𝗴𝗶𝗻𝗴 The property management company is as important as the deal itself. Ask: - How long have they been in business? - Do they have experience with this property type? A company that only manages single-family homes won't know how to run a 100-unit building. __ Did I miss anything? What would you add?

After nine years on Wall Street and countless real estate deals, I finally realized something that's been staring me in the face. Every pitch deck leads with the same metric. IRR. And here's the brutal truth: IRR is VOODOO math that tells a story, not THE story. Here's what I wish someone had told me before I started chasing those glossy 25% IRR projections: They're not predictions. They're marketing tools. IRR assumes every dollar you receive can be immediately reinvested at the same rate. Your syndication projects 25% IRR. You get a $50k distribution in year two. According to IRR math, you'll magically find another 25% return for that cash. In what universe does this happen? Reality? That $50k sits in your checking account at 0.5% while you hunt for six months. However, all sponsors know that IRR is THE king, so they (we, the royal we, and me) optimize for it: → Early distributions (even your own money back in some nefarious cases) → Aggressive exit timing assumptions → Rent growth assumptions that can be too aggressive So what actually matters? Cash-on-Cash Returns: What percentage comes back as actual cash each year? Equity Multiple: How much total cash vs. what I invested? Stress Testing: Does this work with flat rents for 3 years? The question that's saved me millions: "If nothing goes according to plan, do I still get my money back?" Real wealth comes from distributions you can count on, not projections you can't. I broke down the entire IRR deception in this week's article – including the Modified IRR that solves the reinvestment problem and real examples showing how IRR drops from 24% to 16% with realistic assumptions. 👉 https://lnkd.in/gaZRTHkp What's the worst IRR projection vs. reality gap you've seen?