Investment Metrics Glossary
Capitalization Rate (Cap Rate)
Definition
Capitalization rate (cap rate) is the ratio of a property’s net operating income to its purchase price or current value, expressed as a percentage. It measures unleveraged annual return at a single point in time and lets investors compare assets priced differently across markets and property types.
How it works
Cap rate is a pricing shorthand. Divide NOI by value and you get the yield the property produces before financing, income taxes, and capital items. Invert it (value equals NOI divided by cap rate) and the same ratio becomes a valuation tool. Raise NOI or compress the cap rate, and value rises.
The number carries little information on its own. It only means something against a comparison set. A cap rate reflects what buyers will pay for one dollar of income from a specific asset. The price also reflects its submarket, tenant roster, and lease structure. Longer lease terms, stronger tenant credit, and newer construction push cap rates down, because the income stream is more predictable. Short remaining lease term, deferred maintenance, and thin tenant demand push them up, because the buyer absorbs more risk on future income.
Two adjacent metrics get confused with it. Cash-on-cash return measures pre-tax cash flow after debt service against the equity actually invested. It moves with loan terms; cap rate ignores the capital stack entirely. Yield on cost divides stabilized NOI by total basis, including construction and leasing costs. Developers underwrite toward this figure. The exit cap rate is the rate expected at sale.
Three cautions. Cap rate is a snapshot, not a return: it says nothing about rent growth, capital expenditures, or the exit. Different parties compute NOI differently, management fees, replacement reserves, and vacancy assumptions move in and out of the number. A low cap rate is not automatically expensive, nor a high one cheap; each is priced risk.
Formula
Cap Rate = Net Operating Income ÷ Property Value
- Net Operating Income (NOI), annual effective gross income minus operating expenses, before debt service, depreciation, and capital expenditures.
- Property Value, purchase price for an acquisition, or current market value for a held asset.
Illustrative example: a property is bought for $1,200,000 and produces $84,000 in annual NOI. $84,000 ÷ $1,200,000 = 7.0%. Held constant, that same 7.0% applied to an NOI of $96,000 implies a value of roughly $1,371,000. Figures are illustrative, not market data.
In practice
Brokers quote a cap rate before a price. Buyers then rebuild the seller’s NOI assumptions to test whether the quoted rate survives their underwriting. Realmo publishes cap rate and valuation estimates across 9M+ U.S. properties, which gives a starting reference point before an offer is priced.
Net Operating Income (NOI)
Net operating income (NOI) is a property’s annual income after operating expenses but before debt service, income taxes, depreciation, and capital expenditures. It measures what the real estate itself earns, independent of how a buyer finances or holds it. This is why NOI drives both valuation and loan sizing.
NOI isolates property performance from ownership decisions. Two investors can buy the same building, one with all cash and one with 65% debt, and the asset produces identical NOI for both. That neutrality makes NOI useful in direct capitalization. The formula is value = NOI ÷ cap rate. Lenders also use NOI in DSCR to size loans.
What belongs in operating expenses is where deals actually get argued. Property taxes, insurance, utilities, management fees, repairs, and turnover costs are in. Mortgage payments, income taxes, depreciation (governed by the Modified Accelerated Cost Recovery System, MACRS), tenant improvements, leasing commissions, and roof replacements stay out. The last three are capital items below NOI, although they consume cash.
The closest adjacent concept is cash flow before taxes, which subtracts debt service and capital reserves from NOI. NOI measures building earnings. Cash flow before taxes measures what reaches the investor after debt service and reserves. Sellers quote NOI because it looks larger. A buyer underwrites both and normalizes NOI with market management fees and replacement reserves, rather than the seller’s understated actuals.
Formula
NOI = Effective Gross Income − Operating Expenses
Effective Gross Income = Gross Potential Rent + Other Income − Vacancy & Credit Loss
Illustrative example. Gross potential rent $500,000, other income (parking, reimbursements) $20,000, vacancy and credit loss of 5% on potential rent = $25,000. Effective gross income = $495,000. Operating expenses of $190,000 give an NOI of $305,000. Figures are illustrative, not market data.
In practice
A broker’s offering memorandum shows a pro forma NOI that assumes full occupancy and no management fee. Recalculate NOI on in-place rents before drafting an LOI. Then compare it with ownership and valuation records for comparable assets on Realmo.
Debt Service Coverage Ratio (DSCR)
Debt service coverage ratio (DSCR) measures how many times a property’s net operating income covers its annual loan payments. A 1.25x DSCR means the asset produces $1.25 of NOI for every $1.00 of principal and interest due. Lenders use DSCR to size loans, set covenants, and monitor performance after closing.
DSCR measures whether a building can pay its lender from operations without a capital call or refinance. The ratio moves with both cash generated and cash owed. Falling rents, anchor vacancy, or higher insurance costs push NOI down. Floating-rate repricing or the end of interest-only periods pushes debt service up. Either direction compresses coverage.
For an owner, DSCR matters most after closing. Loan documents can test the ratio on a rolling twelve-month basis, quarterly or annually. A breach can trigger cash management instead of immediate foreclosure. The lender can sweep excess proceeds, block partner distributions, or require a reserve deposit. Owners who watch only occupancy can miss a covenant breach driven by expense growth.
Lenders underwrite DSCR on their own NOI, not the owner’s. Expect lenders to apply market vacancy, a management fee, and annual replacement reserves per unit or square foot. That underwritten NOI is usually lower than the seller’s stated figure. This is why a deal that pencils at asking price can still come back undersized.
DSCR is confused with debt yield, which divides NOI by the loan amount. Debt yield ignores the interest rate and amortization entirely, so it does not improve when rates fall or when a borrower requests interest-only. Lenders run both: DSCR shows whether the loan can be paid today, debt yield shows how much value cushion stands behind it. Permanent lenders commonly set DSCR floors above break-even. A 1.20x to 1.25x range is a long-standing convention for stabilized assets. Short leases, single-tenant risk, or hospitality can require higher floors.
Formula
DSCR = Net Operating Income ÷ Annual Debt Service
- Net Operating Income, effective gross income less operating expenses, before debt service, capital expenditures, depreciation, and income taxes.
- Annual Debt Service, twelve months of scheduled principal and interest on all loans secured by the property.
Illustrative example: a small industrial building produces $300,000 of NOI. The mortgage requires $240,000 in annual principal and interest. DSCR = 300,000 ÷ 240,000 = 1.25x. If a tenant leaves and NOI drops to $270,000, coverage falls to 1.13x, still above break-even. It is likely below the covenant. That is where distributions stop. Figures are illustrative only.
In practice
Before signing a loan, owners model DSCR at the point where the interest-only period ends and amortization begins. This is because that step-up alone can move coverage by a wide margin on an otherwise unchanged building. Realmo’s property analytics can help you rebuild an underwritten NOI from ownership and use data before a lender does it for you.
NOI and debt-service definitions vary by lender and loan document. Review the specific agreement with licensed counsel or a financial professional before relying on a coverage calculation.
Internal Rate of Return (IRR)
Definition
IRR is the annualized discount rate that makes an investment’s cash flows equal zero present value. Those cash flows include contributed equity, operating distributions, and net sale proceeds. In commercial real estate, IRR compresses both the size and the timing of an investor’s returns into a single percentage.
How it works
IRR answers a question a simple profit figure cannot: how hard did each dollar work, and for how long. Because every cash flow is discounted by the period in which it arrives, money returned early carries more weight than money returned at exit. Two deals that hand back identical total dollars will show different IRRs if one refinances in year two and the other pays nothing until sale.
Sponsors use IRR as the primary hurdle in promote and waterfall structures, so the metric determines how profits split between general and limited partners. Limited partners use it to compare a value-add office deal against a stabilized industrial deal against a bond, on one axis.
The nearest adjacent metric is the equity multiple, which divides total dollars returned by total dollars invested and ignores timing entirely. A 1.8x multiple over three years and a 1.8x over eight are identical multiples and very different IRRs. Read the two together: IRR alone rewards short holds that return little absolute profit, and multiple alone rewards long holds that tie up capital. Cap rate, by contrast, is a single-year snapshot of unlevered income against price and says nothing about a hold period.
IRR also assumes interim distributions are reinvested at the IRR itself, an assumption that flatters high-return deals. Where that distortion matters, analysts run a modified IRR (MIRR) with an explicit reinvestment rate.
Formula
0 = Σ [ CFt / (1 + IRR)^t ], where CFt is the net cash flow in period t and t runs from acquisition (period 0) through exit.
There is no closed-form solution; IRR is solved iteratively, which is why it lives in =IRR() and =XIRR() rather than on a napkin.
Illustrative example
Year 0: −$1,000,000 equity. Years 1–5: $60,000 in annual distributions. Year 5: an additional $1,300,000 in net sale proceeds. Solving for the rate that zeroes out present value gives an IRR of roughly 10.8%. Figures are illustrative and not a forecast of any actual return.
In practice
Deal packages show IRR across downside, base, and upside cases. The spread between those cases reveals more about risk than the base number alone. If base-case IRR depends mostly on exit cap rate rather than NOI growth, the return is a market bet. It is not driven by the business plan.
Equity Multiple
Equity multiple is the ratio of total cash an investor receives to the equity that investor put in. A 1.8x multiple means every dollar contributed came back as $1.80, original capital included. It measures how much money a deal returns in total, not how fast it returns it.
The equity multiple measures how many dollars return for each dollar of equity invested. It counts every distribution, including operating cash flow and net proceeds from a sale or refinance. Above 1.0x, the position returned more than it consumed. At 1.0x, capital came back and nothing else did. Below 1.0x, principal was lost.
The calculation ignores when money arrives, which makes the multiple blind to time. That is precisely where it separates from internal rate of return (IRR), which discounts each cash flow by its date. One deal returns 2.0x over four years. Another returns 2.0x over eleven years. The multiple is identical, but the IRRs are far apart. Sponsors report both because each covers the other’s weakness: IRR rewards speed, while the multiple tests whether that speed produced meaningful dollars. An early refinance can post a strong IRR while returning modest total capital.
Multiples are also quoted gross or net of fees and promote, and the gap is real. An LP-level net multiple sits below the deal-level gross multiple in any structure with a sponsor promote. Confirm which basis a pro forma uses before comparing two offerings.
Formula
Equity Multiple = Total Distributions ÷ Total Equity Invested
- Total Distributions, all cash received by the investor: periodic distributions plus net capital events.
- Total Equity Invested, initial contribution plus any capital calls.
Illustrative example: an LP contributes $2,000,000, receives $600,000 in distributions across the hold, and receives $2,900,000 at sale. Total distributions of $3,500,000 ÷ $2,000,000 = 1.75x. Figures are illustrative only.
In practice
In an offering memorandum, the projected multiple usually sits beside a target IRR and a stated hold period. Experienced LPs read all three together, because none of them is interpretable alone.
Projections in a private offering are estimates, not outcomes. Investors evaluating a specific sponsored deal should consult a licensed investment or legal professional.
Cash-on-Cash Return
Cash-on-cash return measures the annual pre-tax cash flow a property generates against the cash an investor actually put into the deal. Stated as a percentage, it excludes appreciation, principal paydown, and tax effects, isolating what a single year of ownership returns on out-of-pocket dollars.
Cash-on-cash return measures annual cash received for each dollar of equity invested at closing. The denominator is actual cash out of pocket: down payment, closing costs, lender fees, and upfront capital work. Financing terms therefore move the metric. Two investors buying identical buildings at identical prices can post different cash-on-cash returns because one borrowed more or borrowed cheaper.
That sensitivity to leverage is exactly what separates it from cap rate. Cap rate divides net operating income by purchase price and deliberately ignores the loan, which makes it useful for comparing assets across a market. Cash-on-cash divides after-debt cash flow by equity, which makes it useful for comparing deal structures rather than buildings. It also differs from IRR, which discounts a full hold period including sale proceeds; cash-on-cash looks at one year and says nothing about the exit.
The metric is common in acquisition screening, lender conversations, and LP reporting, where investors want a plain read on current yield. Its weakness is scope. Heavy near-term rollover can produce a strong first-year figure and a weak third year. Practitioners calculate the metric for each projected year instead of quoting one number.
Formula
Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Invested
Annual pre-tax cash flow = net operating income − annual debt service. Total cash invested = down payment + closing costs + upfront capital expenditures.
Illustrative example. A $2,000,000 building purchased with 30% down ($600,000) plus $50,000 in closing costs and initial repairs means $650,000 invested. If NOI is $130,000 and annual debt service is $95,000, cash flow is $35,000. Cash-on-cash return is $35,000 ÷ $650,000 = 5.4%.
In practice
Sponsors quote year-one cash-on-cash in offering materials, and it is the first figure most passive investors check. Since the metric is pre-tax, actual after-tax results depend on depreciation and the investor’s own position, a question for a licensed tax professional.
Gross Rent Multiplier (GRM)
Gross Rent Multiplier (GRM) is a screening ratio. It divides a property’s price by its gross annual rental income, showing how many years of gross rent the purchase price represents. Because GRM ignores operating expenses, vacancy, and financing, it ranks deals quickly but never substitutes for full underwriting.
GRM measures how expensive a building is relative to the rent it collects. A lower GRM means more gross income per dollar of price. Investors use it to reduce a long listing set before requesting operating statements.
The distinction that matters most is GRM versus cap rate. Cap rate divides net operating income (rent after operating expenses) by price. GRM uses gross rent and stops there. Two properties can carry identical GRMs and very different cap rates: on a net-leased industrial building where the tenant covers taxes, insurance. Maintenance, gross rent sits close to NOI, so GRM tracks cap rate reasonably well. On a gross-lease office building where the landlord absorbs the operating load, the same GRM can hide a far weaker return.
Confirm the basis before comparing numbers. Commercial practice states GRM on annual rent; small residential brokers quote it monthly, producing a figure roughly twelve times smaller. Check whether the rent figure is scheduled gross income or actual collections. A fully leased pro forma and a partly vacant asset produce different multipliers.
Formula
GRM = Purchase Price ÷ Gross Annual Rental Income
Illustrative example: a property priced at $2,400,000 with $300,000 in gross annual rent carries a GRM of 8.0. Rearranged, the same multiplier applied to $275,000 of rent implies a $2,200,000 price. Figures are illustrative only.
In practice
Brokers use GRM in offering memoranda and first-call conversations because rent roll data is available before expense data is. Once the seller releases operating statements, underwriting shifts to NOI and cap rate.
Effective Gross Income (EGI)
Effective gross income is the rental income actually collected after vacancy and credit losses. It then adds parking, storage, signage, expense reimbursements, and other income. EGI is the top line of a working operating statement and the starting point for calculating net operating income.
EGI sits between two numbers owners see constantly and confuse. Potential gross income (PGI) assumes every space is leased at market rent and every tenant pays on time, a ceiling, not a result. EGI adjusts that ceiling for reality: units sitting empty between tenants, free-rent concessions, tenants who stop paying, and space held off-market for renovation. It also adds income streams a rent roll misses. In many assets, those streams separate a thin deal from a workable one.
The distinction from net operating income matters just as much. EGI is a revenue figure; NOI is what survives after operating expenses. Two properties can post identical EGI and very different NOI depending on tax load, utility structure, and how much of the expense base tenants reimburse.
For an owner, EGI is the line where operational decisions become visible. Faster turns, tighter credit screening, and monetized parking all show up here before they reach NOI. It is also the line lenders and buyers re-underwrite hardest, because a seller’s vacancy assumption is the easiest number in a package to make optimistic.
Formula
EGI = Potential Gross Income − Vacancy and Credit Loss + Other Income
Illustrative example. A retail strip has PGI of $400,000. Vacancy and credit loss is underwritten at 7%, or $28,000. Other income (CAM reimbursements, a pylon sign lease, and percentage rent) totals $35,000. EGI is $400,000 − $28,000 + $35,000 = $407,000. Figures are illustrative, not market data.
In Practice
Underwriters discard the seller’s stated vacancy factor and re-run EGI against trailing-12 collections and the actual rent roll. Where reimbursements are a large share of other income, EGI is only as durable as the leases that generate them.
Operating Expense Ratio (OER)
The operating expense ratio (OER) measures what share of a property’s effective gross income is consumed by day-to-day operating costs. It is calculated as total operating expenses divided by effective gross income. It excludes debt service, capital expenditures, and depreciation, so it isolates operating efficiency from financing decisions.
OER answers a direct ownership question: how much of the rent you actually collect never reaches the bottom line. The denominator is effective gross income (scheduled rent plus reimbursements and other income, less vacancy and credit loss) not the asking rent roll. The numerator covers the recurring cost of keeping the building open: property taxes, insurance, utilities, repairs and maintenance, janitorial, management fees, and administrative costs. Debt service, tenant improvements, leasing commissions, and capital replacements stay out. Those are financing and capital items, and folding them in makes the ratio incomparable across buildings.
The ratio varies more by lease structure than by owner skill. A single-tenant building on an absolute net lease can show an OER near zero at the owner level, because the tenant pays operating costs directly. A gross-leased multi-tenant office building carries the full expense load, and a hotel, which sells a service rather than space, sits highest of all. Compare OER only within the same property type, lease structure, and market.
The closest neighboring metric is NOI margin, which is the mirror image: NOI margin = 1 − OER. Where OER frames the building as a cost center, NOI margin frames it as an earnings stream.
Formula
OER = Total Operating Expenses ÷ Effective Gross Income
- Total Operating Expenses, recurring costs of operating the asset, before debt service and capital items
- Effective Gross Income (EGI), potential gross income plus other income, less vacancy and collection loss
Illustrative example: a property with $800,000 in EGI and $300,000 in operating expenses has an OER of 37.5% ($300,000 ÷ $800,000). Figures are illustrative only.
In practice
Lenders and appraisers benchmark OER against comparable properties during underwriting. A ratio well below the peer set usually signals deferred maintenance or an expense year that missed a tax reassessment, rather than superior management.
Debt Yield
Debt yield is a lender’s measure of loan risk: net operating income divided by the loan amount, expressed as a percentage. Debt yield shows the return a lender would earn on its outstanding balance after taking back and operating the property. It ignores interest rate and amortization.
Debt yield strips out the two variables that flatter a loan in a low-rate market. Debt service coverage ratio depends on the interest rate and the amortization schedule. A longer amortization period or a cheaper coupon can push DSCR to an acceptable level on a property that has not improved at all. Loan-to-value depends on an appraisal, which depends on cap rates that move with sentiment. Debt yield depends only on the property’s income and the size of the loan. This is why lenders use it as a floor that the other two tests cannot talk them out of.
For an owner planning a refinance, this is the constraint that sets maximum proceeds. Loan size becomes a function of trailing NOI, not of what rates have done since the last closing. Losing an anchor tenant or absorbing higher operating expenses reduces available proceeds with the NOI decline. Falling interest rates do not erase that effect. Minimum debt-yield requirements depend on asset type and lender. Hotels and other operating-intensive assets require higher yields than stabilized multifamily with agency execution (Fannie Mae and Freddie Mac programs).
Formula
Debt Yield = Net Operating Income ÷ Loan Amount
NOI (annualized net operating income, usually underwritten by the lender rather than taken from the owner’s pro forma. Loan Amount) the full first-mortgage balance, not the funded portion.
Illustrative example: $900,000 of NOI and a 10% lender floor support the maximum loan. The formula is $900,000 ÷ 0.10 = $9,000,000. At an $8,000,000 request, the debt yield is 11.25%, which clears the same floor with room to spare.
In practice
Owners discover the debt yield test late, after a broker has quoted proceeds off LTV. When lender-underwritten NOI falls below the owner’s number, the loan resizes downward. Vacancy, management fees, and capital reserves can cause the gap. Equity must cover it at closing.
Loan terms and underwriting standards vary by lender; confirm specifics with a licensed mortgage professional before relying on any sizing estimate.
Net Present Value (NPV)
Net present value is today’s value of projected property cash flows and sale proceeds after discounting at a required return. It then subtracts invested equity. A positive NPV means the deal clears that return threshold; a negative NPV means it falls short.
NPV converts a stream of uneven future dollars into one number stated in today’s money. Project net cash flow for each hold year and add after-cost sale proceeds in the final year. Discount each amount at the required return, then subtract contributed equity. The discount rate carries the argument: raise it and the future shrinks. This is why two investors can run identical projections on the same building and reach opposite conclusions.
NPV compares deals with different cash-flow shapes. One might be a stabilized asset with flat income. Another might lose money for two years before rents reset. Cap rate ignores timing. NPV prices it.
The closest neighboring metric is internal rate of return (IRR). IRR solves for the discount rate that makes NPV zero and reports a percentage; NPV takes your rate as an input and reports dollars. IRR flatters small, fast deals, since a quick turnaround can post a high percentage on little capital and a short hold. NPV shows scale, how much value the deal adds above your hurdle, not how efficiently it does so. Underwriting teams read the two together, usually alongside the equity multiple.
Formula
NPV = Σ [ CFt ÷ (1 + r)^t ] − C0
- CFt, net cash flow in year t, including net sale proceeds in the final year
- r, discount rate, or required return
- t (period number; n) hold period
- C0, initial equity invested
Illustrative example. Equity of $1,000,000, three-year hold, discount rate of 10%. Cash flow of $70,000, $80,000, and $90,000, plus $1,150,000 in net sale proceeds at exit.
Year 1: 70,000 ÷ 1.10 = $63,636
Year 2: 80,000 ÷ 1.21 = $66,116
Year 3: 1,240,000 ÷ 1.331 = $931,630
Total present value = $1,061,382 − $1,000,000 = NPV of +$61,382
The deal clears a 10% required return with about $61,000 of value to spare, in today’s dollars. Figures are illustrative.
In practice
Arguments over NPV are rarely about the arithmetic, they are about the exit assumption, which usually drives most of the present value. Ground that assumption in ownership records and comparable submarket valuation data. Realmo publishes that data without a paywall. Better grounding matters more than refining minor operating projections.
