Multifamily real estate offers investors a promising avenue for stable cash flow and long-term appreciation. To navigate this landscape successfully, it’s crucial to grasp the essential performance metrics that gauge the viability and profitability of such investments. Here’s a comprehensive guide to key metrics every multifamily investor should understand:

Cash-on-Cash Return (CoC Return):

Cash-on-cash return measures the annual pre-tax cash flow as a percentage of the total cash investment. This metric is your go-to tool for assessing the real-world profitability of a property. It answers the fundamental question: How much cash are you making in relation to your initial investment? Higher CoC returns indicate a more favorable investment, with better cash flow relative to the initial investment.

CoC Returns (%) = (Annual Pre-Tax Cash Flow / Total Cash Investment) x 100

Preferred Return:

A Preferred return, or “pref,” is a fixed percentage of profit distributed to certain investors before others, compensating for higher risk or early-stage capital. Preferred returns are like a nod of appreciation to certain investors. These investors get first dibs on profits, acknowledging their crucial role in the initial stages of the investment. It’s a way of saying, “Thanks for taking the risk; here’s your priority return.”

Internal Rate of Return (IRR):

Internal rate of return represents the average annual rate of return, considering timing and size of cash flows, including income and resale proceeds. Think of IRR as the holistic measure of an investment’s appeal. It considers the entire holding period, providing a comprehensive view of the average annual return. A higher IRR indicates a more attractive investment opportunity over the entire holding period. IRR is calculated by setting net present value (NPV) of cash flows to zero and solving for the rate of return.

Average Annualized Return (AAR):

Average Annualized return assesses the average yearly return without assuming reinvestment of cash flows at the same rate. AAR is useful when evaluating investments with different reinvestment assumptions It ensures a fair evaluation of yearly returns without assuming that all cash flows are reinvested at identical rates, offering a realistic perspective on your investment’s performance.

Equity Multiple (EM):

Equity multiple measures how much an investor can expect to earn for each dollar invested, accounting for both cash flow and capital appreciation. EM is your guide to the overall return on investment. It considers both the property’s income and its potential appreciation, giving you a comprehensive picture. A higher Equity Multiple indicates a more favorable return relative to your initial equity investment.

EM = (Total Cash Flow + Sales Proceeds) / Total Equity Invested

Bottom Line

Understanding these metrics is crucial for multifamily real estate investors. These metrics offer valuable insights into potential returns, profitability, and the overall attractiveness of an investment opportunity. With this knowledge, investors can make informed decisions and compare various opportunities to align with their financial goals and risk tolerance.