EBITDA Matters Most to Valuation

When evaluating what you will pay for a property there are essentially the 4 items to consider: Revenue, EBITDA, Net Cash Flow, Price Appreciation. First, let's go through what each of them are...


Revenue = cash inflows the property will generate

EBITDA = Earnings Before Interest Taxes Depreciation Amortization = Operating Cash Flow

Net Cash Flow = EBITDA less debt payments, taxes and capital investment/renovations

Price Appreciation = how much the property will go up in value


As the title mentioned, EBITDA is my preferred metric; however, let's go through the pros and cons of the others.


Revenue

  • Pros: top line growth is relatively predictable, should be fairly stable, good for approximation of fair market value

  • Cons: if property has high expenses through maintenance, management fees, property taxes, HOAs, etc. the EBITDA and Net Cash Flow are severely impacted

Net Cash Flow

  • Pros: all the moving pieces of the property's cash flow, includes tax payments that are excluded from EBITDA

  • Cons: debt payments are not directly tied to valuation, taxes are a constant for all investors, capital investment/renovations are important but for valuation should be added to your investment in the property and not necessarily cash flow

Price Appreciation

  • Pros: potentially relevant when tied to EBITDA (i.e. Foreword Cap Rate), works for property flips

  • Cons: highly unpredictable


When looking at a property I do look at Revenue and Net Cash Flow as they are a function of EBITDA. Revenue let's me know what's coming in, as well as some insight into the quality of the property and area. Net Cash Flow let's me know my margin of safety on debt payments. But I pretty much ignore Price Appreciation as it makes the investment highly speculative. The caveat to that would be if you want to flip a property with renovations.


While Revenue is a great starting point, if the property has high operating expenses that Revenue is less attractive. If the EBITDA is high enough the cover the debt service with a margin of safety, than the use of leverage can only enhance your returns. EBITDA/Operating gives you insight into both the expenses and amount of leverage needed/


EBITDA/Operating Cash Flows provides the clearest picture of what you should pay for a property. It gives you a true idea of what the property can generate as a business, which is essentially what you're buying when you purchase a cash flowing property.


The REIF Model lays out multiple valuation metrics based off EBITDA/Operating Cash Flows and Revenue to help you determined the fair market value of your property.