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Mortgage rates still dropping, hit another low; 30-year benchmark hits 4.42 percent with 15-year at 3.90 percent
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Sunday, August 15, 2010
10 Basic Real Estate Investment Formulas
Successful real estate investing calls for a wise apprehension of many important financial indicators and formulas. Without them, an investor cannot make wise decisions, which in turn, forbid the investor from achieving his or her investment goal, even lose income on the opportunity.
So to aid you better interpret real estate investing, I've accumulated a group of ten formulas I recommend be used by all investors. These are basic just ten basic formulas to help you in your analysis of your real estate investment.
1. Potential Gross Income (PGI) - This is the property's entire yearly income, assuming that all the space was occupied and all the rent collected. For example, assume you have a 30 unit building and each unit the rent is $1,000. The PGI = 30 units x $1,000 = $30,000.
2. Vacancy & Credit Loss - This is likely rental income lost imputable to unoccupied units or lack of rent by tenants. This is sometimes calculated as a percentage of the PGI, when preparing your projections. For example: $30,000 x .05 = $1,500 is the estimated vacancy loss. The actual vacancy loss is determined on a month to month basis. For example, the units can be rented for $1,000 and you have 3 units rented for $900 and 2 vacant units. This month Vacancy & Credit Loss is 3 units x ($1,000 - $900) + 2 units x $1,000 = $2,300.
3. Gross Operating Income (GOI) - The GOI is the potential gross income - vacancy and credit loss, plus income gained from extra sources such as coin-oprated laundry facilities.
Example: $30,000 - $2,300 + 1,000 = $28,700
4. Net Operating Income (NOI) - Net operating income is one of the most crucial calculations since it acts as a return on the purchase price of the property. It shows an objective measure of a property's income stream.
Formula: NOI = GOI - Operating Expenses (Operating expenses does not include depreciation nor debt service).
Example: $28,700 - $10,100 = $18,600
5. Gross Rent Multiplier (GRM) - It is the ratio of the price of a real estate investment to its yearly rental income before expenses:
Formula: Gross Rent Multiplier (GRM) = Sale Price / Potential Gross Income
Example: $360,000 / 30,000 = 12
The GRM is valuable for comparing and choosing investment properties where operating costs can be anticipated to be consistent across properties. We can employ this data to quickly calculate the value of comparable properties for sale.
6. Capitalization Rate ("Cap Rate") - It is the rate at which you discount future income to ascertain its present value. Capitalization rate is used to forecast the investor's potential return on his or her investment.
Formula: Net Operating Income / Value = Cap Rate
Example: $18,600 / 360,000 = 5.20%
7. Cash on Cash Return - This stands for the ratio between the property's annual cash flow (usually the first year before taxes) and the amount of the initial
capital investment (down payment, loan fees, acquisition costs).
Formula: Cash Flow before Taxes / Cash Invested = Cash on Cash
Example: $7,500 / 110,200 = 6.80%
8. Operating Expense Ratio - This renders the ratio of the property's total operating expenses to its gross operating income (GOI). The operating expense ratio establishes the portion of a property's revenue that is being used to pay maintenance and operational expenses.
Formula: Operating Expenses / Gross Operating Income = Operating Expense Ratio
Example: $10,100/ 28,700 = 48.79%
9. Debt Coverage Ratio (DCR) - This is the ratio between the property's net operating income and yearly debt service for the year. Lenders commonly ask for a DCR of 1.2 or more.
Formula: Net Operating Income / Annual Debt Service = Debt Coverage Ratio
Example: $18,600 / 15,100 = 1.23
10. Loan to Value (LTV) - This assesses what percentage of the property's appraised value is attributable to financing. A high LTV implies bigger leverage or financial risk, whereas a lower LTV means less leverage or lower financial risk.
Formula: Loan Amount / Lesser of Appraised Value or Selling Price = LTV
Example: $245,000 / 360,000 = 68.06%
I hope you find these formulas helpful in yout analysis of your real estate investments.
So to aid you better interpret real estate investing, I've accumulated a group of ten formulas I recommend be used by all investors. These are basic just ten basic formulas to help you in your analysis of your real estate investment.
1. Potential Gross Income (PGI) - This is the property's entire yearly income, assuming that all the space was occupied and all the rent collected. For example, assume you have a 30 unit building and each unit the rent is $1,000. The PGI = 30 units x $1,000 = $30,000.
2. Vacancy & Credit Loss - This is likely rental income lost imputable to unoccupied units or lack of rent by tenants. This is sometimes calculated as a percentage of the PGI, when preparing your projections. For example: $30,000 x .05 = $1,500 is the estimated vacancy loss. The actual vacancy loss is determined on a month to month basis. For example, the units can be rented for $1,000 and you have 3 units rented for $900 and 2 vacant units. This month Vacancy & Credit Loss is 3 units x ($1,000 - $900) + 2 units x $1,000 = $2,300.
3. Gross Operating Income (GOI) - The GOI is the potential gross income - vacancy and credit loss, plus income gained from extra sources such as coin-oprated laundry facilities.
Example: $30,000 - $2,300 + 1,000 = $28,700
4. Net Operating Income (NOI) - Net operating income is one of the most crucial calculations since it acts as a return on the purchase price of the property. It shows an objective measure of a property's income stream.
Formula: NOI = GOI - Operating Expenses (Operating expenses does not include depreciation nor debt service).
Example: $28,700 - $10,100 = $18,600
5. Gross Rent Multiplier (GRM) - It is the ratio of the price of a real estate investment to its yearly rental income before expenses:
Formula: Gross Rent Multiplier (GRM) = Sale Price / Potential Gross Income
Example: $360,000 / 30,000 = 12
The GRM is valuable for comparing and choosing investment properties where operating costs can be anticipated to be consistent across properties. We can employ this data to quickly calculate the value of comparable properties for sale.
6. Capitalization Rate ("Cap Rate") - It is the rate at which you discount future income to ascertain its present value. Capitalization rate is used to forecast the investor's potential return on his or her investment.
Formula: Net Operating Income / Value = Cap Rate
Example: $18,600 / 360,000 = 5.20%
7. Cash on Cash Return - This stands for the ratio between the property's annual cash flow (usually the first year before taxes) and the amount of the initial
capital investment (down payment, loan fees, acquisition costs).
Formula: Cash Flow before Taxes / Cash Invested = Cash on Cash
Example: $7,500 / 110,200 = 6.80%
8. Operating Expense Ratio - This renders the ratio of the property's total operating expenses to its gross operating income (GOI). The operating expense ratio establishes the portion of a property's revenue that is being used to pay maintenance and operational expenses.
Formula: Operating Expenses / Gross Operating Income = Operating Expense Ratio
Example: $10,100/ 28,700 = 48.79%
9. Debt Coverage Ratio (DCR) - This is the ratio between the property's net operating income and yearly debt service for the year. Lenders commonly ask for a DCR of 1.2 or more.
Formula: Net Operating Income / Annual Debt Service = Debt Coverage Ratio
Example: $18,600 / 15,100 = 1.23
10. Loan to Value (LTV) - This assesses what percentage of the property's appraised value is attributable to financing. A high LTV implies bigger leverage or financial risk, whereas a lower LTV means less leverage or lower financial risk.
Formula: Loan Amount / Lesser of Appraised Value or Selling Price = LTV
Example: $245,000 / 360,000 = 68.06%
I hope you find these formulas helpful in yout analysis of your real estate investments.
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