Real Estate formulas/strategies, a study guide

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Net Operating Income (NOI)

Back

NOI = Operating Income – Operating Expenses

Front

Capitalization Rate (Cap Rate)

Back

Cap Rate = NOI / Purchase Price

(Answer is expressed as %)

(NOI = Net Operating Income)

NOTE: What is considered a high cap rate for the area typically produces a large cash flow monthly, but doesn’t appreciate over time.

Whereas, a low cap rate typically doesn’t gush cash flow but has very strong appreciation.

Generally speaking, a higher cap rate is a riskier investment but is also likely a more profitable one.

https://www.forbes.com/councils/forbesrealestatecouncil/2020/04/08/capitalization-rates-explained-why-is-cap-rate-so-important/

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Gross Rental Multiplier (GRM)

Back

GRM = Total Property Cost / Gross Annual Rent

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Loan to Value Ratio (LTV)

Back

LTV = Loan amount / Property value

The loan-to-value ratio is a simple formula that measures the amount of financing used to buy an asset relative to the value
of that asset. It also shows how much equity a borrower has in the home they’ve borrowed against—how much money would be left if they sold the home and paid off the loan. LTV is the inverse of a borrower’s down payment. For example, a borrower who provides a 20% down payment
has an LTV of 80%. The loan-to-value ratio is determined by the mortgage amount divided by the appraised amount. A higher down payment will lower the mortgage payment, thus lowering the loan-to-value ratio.

It is better for the ration to be low than for it to be high!

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Debt Service Coverage Ratio (DSCR)

Back

DSCR =

Net Operating Income / Debt Service

The Debt Service Coverage Ratio (DSCR), or sometimes referred to as Debt Coverage Ratio (DCR) is a metric many lenders use to determine whether a property has enough income to cover the loan.
DSCR is calculated by taking our friend, Net Operating Income (NOI) and dividing by the debt service (principal plus interest).

Most lenders want to see a DSCR of at least 1.2,
which means that the property is generating enough

to pay the debt plus an additional cushion of 20%.

They also want to make sure your cash reserves

(liquid net worth) can comfortably cover expenses

for several months.

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Break-Even Ratio

Back

Break-Even Ratio =

(Operating Expenses + Debt Service) / Gross Income

The Break-Even Ratio is another way to look at how a property is performing in relation to the debt payments. It is similar to the DSCR, but answers a slightly different question – what percentage of the gross income do your total expenses account for? This metric can be used to easily see how much gross income can fall and still stay cash flow positive.

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Internal Rate of Return (IRR)

Back

​0=NPV=t=1∑T​(1+IRR)tCt​​−C0​

where:

Ct​=Net cash inflow during the period t

C0=Total initial investment costs

IRR=The internal rate of return

t=The number of time periods​

The Internal Rate of Return (IRR) basically evaluates the annual return of an investment, using a series of projected cash flows. For an investment property, you might have an initial negative cash flow for a down payment, then small positive annual cash flows while it’s rented out, then a large positive cash flow when it’s sold.

While the concept is relatively simple, the math behind it is not. There are plenty of tools out there that will

calculate IRR for you, including Excel.

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Return on Investment (ROI)

Back

The Cost Method:

The cost method calculates ROI

by dividing the investment gain in a property

by that property's initial costs.

The Out-of-Pocket Method:

The out-of-pocket method is preferred

by many real estate investors because it results in a higher ROI. It takes the current equity of the home divided by the current market value. Note that this differs from the above calculation where the cost method divides the investment gain (not the equity) by the initial total costs

(not the market value).

In order to realize your ROI in actual cash profits, you have to sell the property. Often, a property will not sell at its market value, which will reduce your expected ROI if that was the number you based your calculations on.

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Operating Expense Ratio (OER)

Back

OER=
Total revenue/Total operating expenses​​

The operating expense ratio (OER) is a financial metric that compares a property's operating expenses to its gross operating income, expressed as a percentage. A lower OER indicates better efficiency in managing costs relative to income, typically ranging from 60% to 80% for many properties.

A lower OER typically means the property is being managed efficiently and is more profitable for investors, and that less of the property’s income is covering operational and maintenance costs.

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Price Per Square Foot

Back

Price Per Square Foot =

(Sales Price or Rent Price) / Total Square Footage