Whether numbers are your forte or not, there are certain ratios and calculations every property manager should understand. Following is a look at five key ratios that apply to your property management business, how to obtain them, and what they tell you.
1) Vacancy Rate
Your vacancy rate demonstrates the number of units available or unoccupied versus the total number of units available for rent on a property. The lower your vacancy rates, the better. The formula for this is simple:
Vacancy rate = Total number of unoccupied units in a property ÷ Total number of units in a property
This total can then be converted into a percentage.
While average vacancy rates vary from region to region, according to a January 2011 article on MHN Online, “[President of Axiometrics, Inc. Ron] Johnsey’s forecasts call for the average vacancy rate to drop in 2011 to 5.8 percent—a solid statistic considering apartment properties aim for vacancy rates of 5 percent for optimal rent increases.”
Note that your occupancy ratecan be easily determined by subtracting your vacancy rate from 100 percent. For example, with a vacancy rate of 7 percent:
100% – 7% (vacancy rate) = 93% (occupancy rate)
2) Depreciation
Depreciation helps you determine how much value your property has lost over time due to age and wear and tear. Depreciation is considered an expense and will come into play as a write-off when completing taxes. Note that depreciation is completed over a 27.5 year period and applies only to the actual building on the property, not the land. To calculate depreciation:
Purchase price – Land value = Building value
—then—
Annual depreciation = Building value ÷ 27.5
3) Operating Expense Ratio
The operating expense ratio is simply the ratio between total operating expenses and the gross income of your property. This total amount shows how much of your property’s income is being used to actually support and run the property. Operating expenses include those expenditures that support the operation and maintenance of a property. Gross income is the actual yearly income—this may include not only rent, but also income from things like laundry machines and parking fees.
Operating expense ratio = Operating expenses ÷ Gross income
This total can then be converted into a percentage.
4) Capitalization Rate
The capitalization rate (or cap rate) will help you determine the actual value of a potential investment property, beyond the actual property’s more straightforward appraisal value. In other words, how much can you really expect to make off of this property, once expenses and operating costs are accounted for? To obtain this figure, you’ll need both the operating income and recent sales prices for comparable properties. Once you have both of these amounts, you can figure the cap rate, which will help you determine exactly how valuable a potential investment property will be for you or the potential property owner.
Cap rate = Sales price of a comparable income property ÷ Net operating income of comparable income property
This total can then be converted into a percentage.
5) Net Operating Income
Like cap rates, calculating the net operating income (NOI) of a property will help you determine how valuable it will actually be. In order to determine this figure, you will need to calculate both your gross potential income and vacancy and credit loss (in other words, the realistic loss of rental revenue due to vacancies, etc. based on previous years’ statistics). You can then complete the following calculations.
Gross operating income = Gross potential income – Vacancy and credit loss
—then—
Net operating income = Gross operating income – Operating expenses
Whether you’re attempting to gain a better understanding of where an existing property currently stands or how much a potential property investment will ultimately pay off, the black and white numbers provided by the formulas above will help provide a clear picture of how your current (or future) properties are actually performing.