Benchmarking cash flow of portfolio of rental properties will help you track the overall performance and summarizing accounting information with year-to-year apple-to-apple comparison.
Cap Rate or CR% is widely used to measure annual performance for each property without a consideration of financing costs. Note that Cap Rate is different from GIM (Gross Income Multiplier) method such as “1% rule” without considering underlying costs. Cap Rate is normalized performance indicator that gives you an apple-to-apple comparison regardless where the property is located or how you finance the purchase.
GIM is normally a rule of thumb with some speculation prior to a property acquisition. You may find out the actual CR% is quite far away from the original estimated GIM once you operate in this business due to the following cost factors.
1) Under estimated recurring mandatory costs such as high property taxes, insurance cost, HOA.
2) High Property Management costs.
3) High repair/maintenance costs due to bad tenants
4) Vacancies due to high turn over rate
5) Possible eviction costs
6) Other misc.
Due to these cost factors varying from property to property, you may a quite different result for each of property you own.Based on CR% for each individual property, you can further aggregate the results for entire portfolio with multiple properties for multiple years since the year of each property acquisition. Your rental income may go up and down annually due to various factors such as vacancy, repair/maintenance costs, eviction, etc. The aggregated performance indicator will help balance out the income/loss. In this way, you can see more clearly if your assets are really performing.
On financing side, you may also want to measure how your equity works with financing costs. Your equity is expected to grow while the principal balances decrease unless you added more properties into your portfolio. The equity return measures how the leverage works for you. The financing costs such as interest rate impacts the equity performance.
Comparing Equity return or ER% vs. CR%, you may further find out something interesting as follows:
1) If ER% > CR%, your financing method or leverage works well.
2) If ER% < CR%, your financing cost might be too high.
3) If ER% < 0, you must have a negative cash flow even though CR% > 0.
4) If ER% = CR%, you normally have full equity. i.e. there is no more loan on the property.
If you are interested in finding out how to benchmark your property assets performance using these methods. Please continue reading the next posting.
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