Knowing the Numbers · Commercial Real Estate 101

Knowing the Numbers

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📊 SECTION 1: CAP RATE

What It Is: Cap Rate (Capitalization Rate) is your annual return before debt — based on the property’s income compared to its price.

Cap Rate is like a snapshot of the deal’s raw earning power, before financing. It answers the question: “If I bought this property with cash, what return would I earn each year just from the operations?”

A 6% Cap Rate means you’d earn 6 cents for every dollar you invested — from rents and operations alone. Lower cap rates usually show up in safer, high-demand markets. Higher cap rates often come with more risk — maybe a rougher property, unstable tenant base, or management issues.

But here’s the key: Cap Rate doesn’t factor in your loan, your cash invested, or your long-term strategy. It’s a tool — not the deal itself.

Why It Matters:

Quick way to compare deals
Gauges return and market value
Lower Cap = safer asset, Higher Cap = potentially higher return

Cap Rate

Formula: Cap Rate = NOI ÷ Purchase Price

Example:

NOI = $100
Purchase Price = $1,250
Cap Rate = 100 ÷ 1,250 = 0.08 or 8%

📊 SECTION 2: NET OPERATING INCOME (NOI)

What It Is: NOI is the income a property produces after subtracting operating expenses — but before debt.

NOI is the engine of your multifamily property. It’s the money the property produces after you’ve paid all the bills — but before the mortgage. It tells you how well the property performs on its own, regardless of how you finance it.

Lenders look at NOI to decide how much they’re willing to lend. Investors use it to calculate Cap Rate, DSCR, and value. When NOI goes up, the value of your property usually goes up with it — and when it drops, everything else does too.

The goal? Drive NOI higher through rent increases, reduced expenses, and improved operations — because NOI is the number that drives value.

Why It Matters:

Used to calculate Cap Rate, DSCR, and value
Determines how much income is available to pay the mortgage
Key factor in loan sizing

Net Operating Income (NOI)

Formula: NOI = Gross Income – Operating Expenses

Example:

Gross Income = $250
Expenses = $150
NOI = 250 – 150 = $100

📊 SECTION 3: CASH-ON-CASH RETURN

What It Is: Your return on actual cash invested — a favorite for active investors.

Cash-on-Cash is the number most investors care about when they ask, “What am I earning on the money I put in?”

It’s simple: how much cash do you get back each year, compared to what you invested up front? If you put in $100K and earn $10K a year in cash flow, you’re getting a 10% return. No fancy formulas — just a straight look at how hard your money is working.

It’s perfect for comparing deals. And while it doesn’t account for appreciation or tax benefits, it tells you how much cash is coming back into your pocket each year — and that’s the number most of us feel first.

Why It Matters:

Measures how hard your cash is working
Great for comparing deals with different leverage or down payments

Cash-on-Cash Return

Formula: Annual Cash Flow ÷ Cash Invested

Example:

Annual Cash Flow = $100
Cash Invested = $1,000
CoC Return = 100 ÷ 1,000 = 10%

📊 SECTION 4: DEBT SERVICE COVERAGE RATIO (DSCR)

What It Is: DSCR shows how easily a property can pay its mortgage from its income.

DSCR shows whether your property is making enough money to cover the loan payment. Banks love this number — and so should you.

If your NOI is $120,000 and your annual loan payments are $100,000, your DSCR is 1.2. That means you’re earning 20% more than you need to keep the bank happy.

Most lenders want a DSCR of 1.25 or higher. If you’re below that, you’re skating close to break-even. If you’re above it, you’ve got breathing room — and investors love breathing room.

Benchmarks:

1.25 = Strong
1.00 = Break-even
Below 1.00 = Risk of negative cash flow

DSCR (Debt Service Coverage Ratio)

Formula: NOI ÷ Annual Debt Payment

Example:

NOI = $100
Debt Payment = $80
DSCR = 100 ÷ 80 = 1.25

📊 SECTION 5: PRICE PER DOOR

What It Is: The average price per unit — helps you compare deals quickly.

Price per door is simple math — but a powerful comparison tool. It tells you the average cost per unit, which helps you benchmark similar properties quickly.

If two 20-unit buildings are priced the same, but one has stronger rents and better finishes, the higher price per door might make sense. But if the rent potential isn’t there, that extra cost could be a red flag.

Just remember…price per door doesn’t tell you income — it only tells you cost. Always pair it with Cap Rate or NOI to get the full picture.

Why It Matters:

Useful comparison metric
Doesn’t show income — combine with Cap Rate or NOI for full picture

Price Per Door

Formula: Purchase Price ÷ Number of Units

Example:

Price = $1,000
Units = 10
Price Per Door = 1,000 ÷ 10 = $100

📊 SECTION 6: OPERATING EXPENSE RATIO (OER)

What It Is: Shows what portion of income goes to operations.

OER reveals how efficient your property is. It tells you what percentage of your income is being eaten by expenses.

An OER of 50% means half of your revenue is going to bills. That might be okay for a certain asset type — or it might signal a bloated operation or poor management.

Lower OER = more profit per dollar. But don’t go too low — some expenses are necessary to keep tenants happy and protect your profit.

Track this number, benchmark it, and use it to spot operational leaks.

Benchmarks:

40–60% = Typical
Over 60% = Watch for inefficiency
Under 40% = Often newer or well-run assets

Operating Expense Ratio (OER)

Formula: Operating Expenses ÷ Effective Gross Income

Example:

Expenses = $100
Gross Income = $250
OER = 100 ÷ 250 = 0.40 or 40%

📊 SECTION 7: BREAK-EVEN OCCUPANCY

What It Is: Minimum occupancy needed to cover all expenses and debt.

This is your safety buffer. Break-even occupancy tells you how low your occupancy can drop before you start losing money.

If your break-even is 85%, and you’re currently 95% full, you’ve got a 10% margin of error. But if you’re sitting at 88% and your break-even is 87%… that’s too tight for comfort.

Great operators know this number cold — and they manage to stay well above it. It’s one of the best ways to measure risk.

Why It Matters:

Tells you how much vacancy you can handle
Lower break-even = safer investment

Break-Even Occupancy

Formula: (Operating Expenses + Debt Payments) ÷ Gross Potential Rent

Example:

Operating Expenses = $60
Debt Payments = $40
Gross Potential Rent = $100
Break-Even Occupancy = (60 + 40) ÷ 100 = 1.00 or 100%

📊 SECTION 8: REVERSION CAP RATE

What It Is: The cap rate you assume when estimating the property's resale value at exit.

Your reversion cap is your “exit assumption.” It’s what you think the Cap Rate will be when you sell the property in the future.

A conservative reversion cap (usually 0.5% to 1% higher than your entry cap) protects you from overestimating your sale price.

If the market softens, you’re prepared. If it stays hot or gets better, you win bigger. Either way, modeling your exit with a smart reversion cap shows lenders and investors that you’re realistic — not just optimistic.

Why It Matters:

Drives your exit valuation
Conservative assumptions protect your pro forma
Common to assume a 0.5%–1% higher cap than entry

Reversion Cap Rate / Exit Price Estimate

Formula: Sale Price = NOI ÷ Reversion Cap Rate

Example:

NOI = $100
Reversion Cap = 6%
Sale Price = 100 ÷ 0.06 = $1,666.67

📊 SECTION 9: LOAN-TO-VALUE RATIO (LTV)

What It Is: The portion of the purchase financed by debt.

LTV tells you how much of the purchase is financed with debt. A 75% LTV means you’re borrowing 75% and putting in 25% cash.

It affects your leverage, your risk, and your cash-on-cash return. Higher LTV = more leverage = less cash in… but also more debt to manage.

Find the balance that fits your risk profile. Lenders usually cap it at 65–75%, but smart investors choose LTV based on their comfort with cash flow swings.

Why It Matters:

Affects financing risk
Most lenders want LTV at 65%–75%
Higher LTV = less cash in, but more leverage

Loan-to-Value Ratio (LTV)

Formula: Loan Amount ÷ Property Value

Example:

Loan = $750
Property Value = $1,000
LTV = 750 ÷ 1,000 = 75%

📊 SECTION 10: INTERNAL RATE OF RETURN (IRR)

What It Is: IRR is your average annual return, factoring in when you receive your money. It includes all cash flow plus the resale profits.

IRR is the most powerful — and most complex — number in your toolkit. It measures your total return over time, factoring in when you receive your money.

Unlike cash-on-cash (which looks at annual income), IRR takes into account your full investment life cycle — including future cash flows, capital events, and your final sale.

A good IRR depends on the deal type, risk, and holding period. But in general: the higher the IRR, the better the return over time — assuming your projections hold.

Why It Matters:

Helps compare long-term deals
Accounts for time value of money
The more accurate your forecast, the more powerful IRR becomes

IRR requires software to calculate precisely, but here’s a helpful analogy substitute:

If you invest $100 today, and 5 years later you receive $150 total (including cash flow + sale), your IRR would be between 8–9% depending on how fast the money came back. Faster = higher IRR.

Easy IRR Rule of Thumb: