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Metrics for Evaluating Commercial Real Estate

In addition to the capitalization rate (cap rate) and interest rates, there are several other important metrics that investors should consider when evaluating a potential commercial real estate investment. Here are some of them:


  1. Internal Rate of Return (IRR): IRR is the rate of return on each dollar invested for each period of time that it is invested in. It is often advertised by sponsors of deals as an indication of the potential return that an individual can earn on their investment.  IRR is helpful in that it takes into account the time value of money, but it is not helpful when evaluating the investments absolute return unless an exit value of the investment can be properly estimated.

  2. Equity Multiple: Equity multiple is the ratio of cash received to cash invested. It is a measure of how much money an investor can expect to receive back from their investment. This is another metric that needs a projected exit price to be meaningful.  Generally, real estate deals are looking for 1.5-2.5x for the equity multiple.

  3. Cash-on-Cash Return: Cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested in a property.  This is a helpful metric to show the power of leveraging debt as part of the capital stack.

  4. Debt Service Coverage Ratio (DSCR): DSCR is a measure of a property’s ability to cover its debt payments. It is calculated by dividing the property’s net operating income by its annual debt service.  This is a common metric used by banks.  Most lenders are looking for a DSCR of 1.2 or higher.

  5. Gross Rent Multiplier (GRM): GRM is a ratio used to estimate the value of an income-producing property based on its gross rental income. It is calculated by dividing the property’s sale price by its gross rental income.  This number does not tell us much by itself but is helpful when comparing multiple investment opportunities.  Furthermore, it does not consider expenses so it can be misleading.

  6. Return on Investment (ROI): ROI is a measure of how much money an investor can expect to earn on their investment. It is calculated by dividing the profit generated by an investment by the cost of the investment.

These metrics can help investors assess the potential profitability and risk associated with a commercial real estate investment.  At Sovereign Sage, we will look at these metrics to ensure that we are bringing high-quality, risk-mitigated, strong-return investments to you.  We will do the heavy lifting to allow you to invest confidently.

 

 

Make the wise decision,

 

Jay Kennedy

On behalf of the Sovereign Sage Team

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