There is more to real estate investment than the property itself. A few decisions need to be made before you purchase the property. You will need to know certain calculations to make the right decision.
The Question you should ask yourself first; Are you holding the property as a rental or are you going to rehab it and flip the property?
Remember, your profit is usually determined when you buy the property, not when it sells. This means, if you buy the property for the right price, you will receive the profit margins predicted.
Using a Realtor, you can get help with some of the information you will need to complete the formulas or double-check the numbers. Websites like Zillow and other public sites offer FREE VALUATION but can provide inaccurate information.
Gross Scheduled Income
The Gross Scheduled Income Formula presents the amount of income your property will generate if all units within it are rented and if there are no defaults in rent payments. This can be a useful measure to compare against actual income.
Talk with your Realtor to view comparable rentals in the area. Many investors guess the rental amount or set the amount catered towards a return on investment. However, rental comps are as crucial as sales comps for marketing the property, You want to be conservative in your calculations while testing the cap in the market of your property’s location.
Gross Scheduled Income = Rental Income + Lost Rental Income From Vacant Units
Gross Operating Income
Gross Operating Income reflects the total income generated by an asset including additional sources of income from your rental property. A few examples would be the revenue generated from parking spaces, laundry, and vending machine
Gross Operating Income = (GSI – Lost Rental Income From Vacant Units) + Other Income
Net Operating Income
To use the Net Operating Income formula, you first need to figure out your gross operating income. Once you have that figure, you subtract operating expenses from costs like insurance and maintenance fees.
Please note, amounts like property depreciation and interest payments do not factor into operating costs.
Net Operating Income = Gross Operating Income – Total Operating Expenses
An important formula for an investor to know is the Cap Rate. The cap rate formula compares an investment property’s net operating income against the market value, allowing investors to quickly compare property profitability.
Cap Rate = Net Operating Income / Market Value Of Property
Cash On Cash Return
Determining your Cash on Cash Return is crucial in real estate investing. It’s widely utilized since it allows investors to compare investments and evaluate profitability. A spreadsheet is a great way to view side-by-side comparisons between properties that are similar. By setting up a spreadsheet with formulas, you can quickly calculate income and expenses to estimate returns.
To use the cash on cash return formula, you simply divide the net operating income by your total cash investment. Typically, your total cash investment will include the down payment, closing costs, renovation costs, and any other up-front fees you paid to acquire the investment property
Cash On Cash Return = Net Operating Income / Total Cash Investment
Equity Build-Up Rate
Smart real estate investments do not always come in the form of immediate income. Some properties are sought after due to their potential to build equity, therefore becoming more valuable assets in the future. This simple real estate formula can help in measuring these gains.
Consulting with a Realtor is a good way to see how quickly an area is growing in value.
Equity Build-Up Rate = Mortgage Principal Paid / Initial Cash Invested
Price To Rent Ratio
This figure shows projected rental income, versus the price a property was purchased for. This is useful when comparing residential real estate investments. Like other calculations, a spreadsheet with formulas can assist with quicker decisions.
Price To Rent Ratio = Purchase Price Of Property / Annual Rental Revenue
Price Per Square Foot
The price per square foot formula proves useful when quickly comparing multiple properties. Savvy investors can use this calculation to evaluate if a rental property is overpriced before it is purchased. Your Realtor can help you evaluate this in-depth by pulling both rental and sales comps, which list the price per square foot (as-is, not post-rehab).
Price Per Square Foot = Market Value Of Property / Property Square Footage
Return On Investment
The return on investment formula allows you to calculate how much of your initial investment can be recovered annually.
Return On Investment = Annual Returns / Cost Of Investment
Cash Flow From Operations
Successful real estate investments should require more money coming in than going out. You need to subtract your capital expenditures (roughly defined as large expenses that do not reoccur) from your net operating income to determine cash flow from operations.
Cash Flow From Operations = Net Operating Income – Capital Expenditures
Cash Flow After Financing
Considering that most real estate investors have borrowed money in order to purchase their investment, this cash flow formula can provide a better idea of what your cash flow is like after financing
Cash Flow After Financing = Cash Flow From Operations – Financing Costs
Occupancy Rate reflects the time that an investment property is rented out or vacant over a period of time. Your occupancy rate is an important indicator of success, and a low occupancy rate can let you know that action is needed from your end.
Low occupancy can occur when properties are in need of repair. People tend to seek alternative housing if a landlord is not maintaining the property or did not complete some repairs required previously. Landlords can “promise” to fix things to get people to move in, while in turn causing them to move out as fast.
Occupancy Rate = Number Of Days Occupied / Total Number Of Days In One Year
This figure is often used to evaluate risk when purchasing a real estate investment. Too high of a ratio can indicate an uphill battle to break even with an investment property and recoup debts.
Break-Even Ratio = (Debt Servicing Costs + Operating Expenses) / Gross Operating Income
Gross Rent Multiplier
The Gross Rent Multiplier real estate formula allows investors to figure out the market value of a rental property. This is especially useful when selling a rental property, as it helps set the right price without wasting days on market.
You will want to compare notes with a Realtor. This calculation can help set the value based on the numbers, but it is always good to have a second pair of eyes.
Gross Rent Multiplier = Market Value / Gross Scheduled Income
Debt Service Coverage Ratio
This real estate formula can be used to figure out the current cash flow you have available to recoup the debt which financed your investment.
Debt Service Coverage Ratio = Net Operating Income – Annual Debt Service