The Best KPIs to Manage Your Rental Real Estate Portfolio
This is a guest post written by Thomas Castelli of The Real Estate CPA
Traditional real estate portfolio management reports provided by accounting firms include a Profit & Loss Statement (P/L), a Balance Sheet (B/S), and Statement of Cash Flow.
The Profit & Loss shows the income and expenses for any given period, the Balance Sheet shows a company’s assets and liabilities for any point in time, and the Statement of Cash Flow shows how the cash was utilized for a given period.
The flaw of traditional accounting reports like these is that they report the facts for a given period but fail to provide any actionable information. What factors contributed to those outcomes?
When we think about the current landscape in real estate accounting, a few key areas stand for improvement:
Generating digestible and actionable reports for managers and investors
Reporting needs to be as real-time as possible, offering a continuous source of insight for recipients
Reports should include benchmark data to quickly compare performance of assets to that of their peers and identify strategic opportunities.
Digestible and Actionable Reports
What do we mean by digestible and actionable? Let’s take an example:
An investor owns 4 rental properties in the same market but they are all different sizes (i.e. Duplex vs 10-unit). You receive a profit and loss statement from your accountant for each property. Upon examining the report you look at the operating expenses for each property as follows:
Property A - $1,500
Property B - $2,400
Property C - $1,325
Property D - $3,245
Since all these properties are different sizes, it doesn’t tell you much. However, if you were to look at the operating expense ratio (OER: divide a property's operating expense by its gross operating income) instead of the raw operating expense figure you get from the P/L, you discover the following:
Property A – 41%
Property B – 39%
Property C - 63%
Property D – 41%
Now you have actionable, digestible data to work from. If the OER for 3/4 properties is about 39%-41%, why is Property C’s 63%?
Something’s wrong, and upon further examination you see that the utility expense ratio for Property C is also above average and decide to investigate.
You discover a leaking pipe on Property C that is causing an above average water bill and then have a plumber come and fix it, crisis averted.
Generating Reports the Right Way
Putting together any accounting or financial report involves making sure the bookkeeping is correct (transactions are properly categorized) and then performing journal entries to reflect financial changes outside of the accounting software. The time it takes to do this varies based on the skill of the bookkeeper, but this is the foundation of all reporting. Without a strong foundation and accurate books, your report data can be misleading.
Putting together more specific reports with actionable, digestible metrics and visualizations can take hours depending on the amount of data that needs to be put into a given template. That’s where a software like Malartu can significantly reduce the time it takes to create these types of reports. In fact, scroll to the bottom of this post for a free-trial of our pre-built template for rental real estate investors.
But that brings us to our next point: Alone, these metrics won’t tell you all that much. You need to know what you’re looking for in the data to make it meaningful.
Keeping Your Focus
In many cases, dashboards and reports help tell a valuable story even when analyzing just a few metrics. For example, a glance at a comparison between your utilities expense ratio and industry benchmarks will immediately shed light on strategic opportunities you may have been missing.
In most industries and niches there are a select few metrics we refer to as “north star” metrics. We like to think of this metric as the one that’s the most important to keep on track, all things considered.
It’s not always possible to peg just one “north star,” but if we had to pick one for rental real estate and portfolio management it would be net operating income (NOI), closely followed by the internal rate of return (IRR) for each investment.
The higher a property’s net operating income, the more the property is worth. Plain and simple. It is a key part of calculating a properties capitalization rate (cap rate), which is a common metric used to compare real estate investments. It can be argued that the cap rate is really the “north star” and not NOI, but because the cap rate varies market to market, focusing on increasing NOI through increasing revenue (i.e. rents) and reducing expenses will almost certainly steer you in the right direction.
The other guiding metric (let’s call it “Sirius,” the brightest star in the sky), would be the IRR. The IRR is a metric sophisticated investors use to measure ROI, compare investment opportunities, and determine the optimal selling point. This is because IRR takes into account both the timing and magnitude of future cash flows. In many cases, the higher the IRR the better, and the longer an investment can sustain a high IRR, the better. The year (or other period) the IRR peaks, indicates the property’s optimal selling point.
Real Estate is in Our Name
At The Real Estate CPA (Hall CPA), we exclusively service real estate investors and business owners, which allows us to have a deep understanding of the various accounting and tax strategies available to this select group.
Meanwhile, other accounting firms service several different industries, which makes having this deep level of understanding about any particular industry difficult and leads to missing key strategies that can help real estate investors, especially as it pertains to advisory services.
All of our CPAs are real estate investors themselves or grew up in a real estate family, which allows us to provide unique operational insights that other accountants may never see.