Five Important metrics real estate investors in Uganda need to track

Analyzing real estate investments can be a daunting experience if you don’t know what to look out for.  Performance varies relative to expectations, meaning that a property can perform excellently on one aspect and at the same time disappoint on another metric. Depending on the investor’s goals, one can establish how well an asset will serve the intended investment purpose.

Several metrics exist to help investors quickly assess how well a property will do. This article discusses five important metrics real estate investors in Uganda need to track.

1.      Net Operating Income. (NOI)

This is used to determine whether a property is profitable or not. It is obtained by adding up all revenue generated from the building, such as rent, laundry services, parking fees, and the like, and then subtracting reasonable operating expenses like maintenance and repairs, cleaning, security services, and property taxes.

If the number is positive, it indicates a profitable property. However, if it is negative, that means the property’s expenses exceed the revenues, resulting in what we call a net operating loss.

Real estate investors use NOI to compare the profitability of different properties. Mortgage lenders and financers use it to determine how much they can lend in terms of a mortgage.

An example would be a case where a property has a monthly rent of USD 1,000 Security guard who is paid USD 150 monthly, a cleaner who earns 100 USD, and an average annual maintenance and repair bill of USD 500.

NOI = Annual revenue – Operating expenses

         = (1000 x 12) – (150 x 12 + 100 x 12)

         = 12000 – 3,000

NOI = USD 9,000

2.      Capitalization rate

Capitalization rate is one of the most used methods of comparing similar income-generating real estate properties. It divides net operating income by the market value of the property and is expressed as a percentage.

The capitalization rate is used to determine the return on investment over one year, assuming that it was purchased on a cash basis. It does not consider leverage, future cashflows from property improvements, or even the time value of money. It therefore should not be used as the sole indicator of an asset’s strength.

Cap rate could be determined in two ways, i.e.

1.      Cap rate = Net operating income / Market value

2.      Cap rate = Net Operating income / Purchase price

The first formula is preferable as it gives a more realistic representation of the property compared to the second formula which may sometimes refer to the purchase price from a long time before. It is also impossible to use the purchase price in cases where the property was simply inherited.

For example, assume a property that’s worth USD 100,000, with a net operating income of USD 8,000.

Cap rate = 8,000 / 100000

Cap rate = 8%

A high Cap rate usually signifies more risk associated with the property, although, at the same time, it represents a higher earnings-to-investment ratio. A lower Cap rate on the other hand represents lower risk stemming from a higher valuation of the property due to various factors like location, property condition, and type of tenants.

Although the capitalization method is reliable in determining the valuation of properties with stable incomes, it is less dependable in cases of irregular incomes.

The cap rate of an investment property should be above the rates provided by safer investments such as government bonds to cater for the risk undertaken by the investor in deciding to invest in a real estate property.  

3.      Cash flow

Cash flow simply refers to money going in and out of your bank account. In real estate investing, you collect money from tenants and other revenue sources associated with the property, say laundry services and parking fees. These sources of income contribute to the money earned by the property.

On the other hand, there are going to be expenses like property management fees, repairs, taxes, mortgages, and interest payments. Cash flow is the difference between your income and expenses on the property.

Consider a property with a monthly rent of USD 2,000 and there is a laundry service of USD 100 per month. Monthly expenses include Property management fees of USD 300, security costs of USD 100, and property taxes account for 30 USD.

Monthly cash flow = Income – Expenses

                                  = (2,000 + 100) – (300 + 100 + 30)

                                  = 1,670 USD

Where your income is greater than your expenditures, you have positive cash flow. In scenarios where your expenses exceed your income, you end up with negative cash flow. Investors need to ensure that their properties have positive cash flow

4.      Cash on Cash return

In commercial real estate, not all properties are purchased with cash outright. Investors usually acquire debt from banks to finance the acquisition of a property. The bank requires that the investor put down an amount, usually a percentage of the total cost of the property, and then they finance the rest. This money is paid back to the bank regularly in the form of mortgage payments.

Investors gauge their actual returns based on what they get out of the property relative to the actual cash they invested.

Cash-on-Cash return is calculated based on Pre-tax cashflows.

An example is an investment whose total price is 100,000 USD. The bank requires a 20% down payment and 80% is financed through a mortgage. In this case, the investor will have only 20,000 USD cash invested in the property. To calculate the cash-on-cash return, you get the cash flows for the year and divide it by the actual cash invested. In this case, if the annual cash flow is 12,000, the cash-on-cash return would be.

Cash on Cash = 12,000 / 20,000

                         = 60%

5.      Internal Rate of Return

Internal rate of return (IRR) is one of the most important metrics that investors in commercial real estate use to compare two or more investment opportunities. It considers the time value of money and lets investors identify which project will make the best use of their capital.

Because you can have two investments paying out cash at different intervals, it is important to determine which one correlates to a higher net present value of cash flows. This originates from the idea that cash today is worth more than cash in the future.

Internal rate of return can also be used to compare the projected performance of a real estate investment vis a vis what the investor could get from other safer investments or the cost of capital.

Projects with higher IRR are generally preferred to those with lower values, but this does not always mean that they are the better investment. It is recommended that an investor uses the IRR in conjunction with other metrics to select the best option that suits their needs.

Real estate investors in Uganda can make use of these metrics to ensure that they make the best picks for real estate investment. As explained above, relying on just one metric could lead to an unfavorable outcome. The best practice is to scrutinize each opportunity using two or three metrics to determine whether it holds up to the expectations of the investor.

To learn more about investing in Uganda’s Real Estate industry, visit https://www.barosgroupltd.com/

About the author;

Benard Sonko is a real estate investment manager and founder of Baros Group Limited. For comments and inquiries, you can reach him at +256742140251 or info@barosgroupltd.com