Real estate benchmarking

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Real estate benchmarking is the standard of measurement used to analyze the financial characteristics of a real estate investment property. In the general sense, real estate benchmarking refers to the comparison of potential real estate investment properties against a predetermined framework of measurement. In a narrow sense, the term real estate benchmarking refers to the specific real estate indicators used to measure the real estate properties.

The individual indicators are referred to as key performance indicators, or KPI for short. Examples include the net cash flow, total rental incomes, or the internal rate of return.

Overview[edit]

Real estate benchmarking consists of a group of real estate financial indicators and their benchmarks. Indicators in general allow investors to remove emotions and speculation out of investing; this is true not just in real estate investing, but on any other investment types such as stock or currency trading. Indicators are particularly important in real estate since it deals with a physical entity- a bricks and mortar structure, which might trigger emotions on the investor based on its architecture and beauty.

The process starts by setting benchmarks for each indicator based on their accept/reject criteria; which subsequently is used to compare the desirability of the real estate properties; thus providing context and point of reference on the properties' financial characteristics and profitability standing.

Types of real estate benchmarking indicators[edit]

There are many real estate financial indicators, however the ones that provide the most value for benchmarking (especially for income producing real estate investments) are:

Real estate indicator benchmarks[edit]

The accept/reject benchmark value for each indicator varies from investor to investor, investors adjust the accept/reject benchmark values according to risk tolerance levels and investment goals.

The following table provides a point of reference about typical accept/reject benchmarking settings for each indicator.

Benchmarking indicator Example accept criteria Example reject criteria Note
Gross rent multiplier Less than 9 Greater or equal 9 The lower the better
Cash on cash return Greater or equal 10% Less than 10% The higher the better
Profitability index Greater or equal 1.0 Less than 1.0 The higher the better
Internal rate of return Greater or equal 10% Less than 10% The higher the better
Debt coverage ratio Greater or equal 1.2 Less than 1.2 The higher the better
Break even ratio Less than or equal 85% Greater than 85% The lower the better
Loan to value ratio Less than or equal 70% Greater than 70% The lower the better
Capitalization rate Greater or equal 7% Less than 7% The higher the better
Net cash flow Greater or equal 10% Less than 10% The higher the better

There is no magic accept/reject criteria for the benchmarking indicators, each investor needs to make the determination on which criteria is appropriate for each particular situation.

References[edit]