At the heart of profitable real estate investment decisions are the math and calculations that you use to make them. That’s why in today’s post, I’m going to walk you through some of the most important formulas that you need to know as a beginner real estate investor. And if you want to learn real estate math in 10 easy formulas, make sure to read this post to the end. Just hearing the word math is appalling for many people.
However, in real estate investing, practice makes perfect. So the more you use these popular formulas to evaluate rental properties, the easier it will get for you until real estate math becomes your second nature. And luckily for you, I’m here to trim the clutter and simplify the 10 must use formulas for far more successful investments that will make your life easier. Let’s get started.
Number 1, net operating income or NOI.
Net operating income is the amount of money left over once you have deducted your operating expenditures and before you pay your debt. This is among the most important numbers you ought to be familiar with as a real estate investment since it is used in numerous other calculations such as cap rate, debt cover ratio, and so on. It considers your gross income, vacancy cost, and operational expenses, including maintenance, repairs, taxes, insurance, and property management among other things. Generally, all expenditures except for the principal and interest on your mortgage obligation and capital expenses. The formula is your net operating income equals your investment property operating income minus your operating expenses.
Number 2, Capitalization rate or cap rate for short.
The capitalization rate, commonly known as the cap rate, is a straightforward metric used to compare similar real estate assets. It effectively informs you what your rate of return would be on an asset if you paid upfront for it. Because debt agreements and amounts can vary widely from transaction to transaction, calculating the cap rate allows you to exclude debt as a factor and evaluate the return on investment as if you’re paying in cash for the investment property. To further appreciate this, consider the following formula.
The cap rate equals the net operating income divided by the property purchase price. So you’re looking at 2 comparable rental properties in the same neighborhood that you can rent out for the same amount of monthly rent. The lesser the acquisition value of your investment property, the greater the cap rate.
Number 3, Rent to cost ratio.
Using the rent to cost ratio, you can quickly determine how similar 2 properties are to each other. You can use this method to filter out real estate assets that you are contemplating buying on a regular schedule before performing a more in-depth investigation into the financials of each investment property. The rent to cost ratio equals the monthly rent divided by the total property cost. This real estate math formula provides you with the monthly rent as a proportion of the overall estate appraised value as well as the cost of whatever renovations are necessary to make the place rentable. This is the rent to cost ratio that is being used to calculate the famous 1% rule. The 1% rule assures that you generate positive cash flow. Each and every investment property and its monthly rental income must equal or exceed 1% of the total.
Number 4, gross rent multiplier or GRM.
The gross rent multiplier is a different approach to the rent to cost ratio. Generally, it provides precisely the same information in a new formula. This is an annualized figure that inverses the relation ship between rent and cost. Many real estate investors prefer the rent cost ratio since it is more straightforward, but you must be aware of what exactly it implies.
The formula is the gross rent multiplier equals the total property cost divided by the gross annual rent. So the gross rent multiplier is calculated by dividing the total acquisition value of the investment property, including any necessary renovations, by the estimated annual gross rental rate.
Number 5 Debt service coverage ratio, DSCR.
The DSCR, also known as the debt coverage ratio, is one of several metrics that real estate investors use to determine whether a rental property generates sufficient income to afford the debt. The DSCR is determined by taking our old buddy, the net operating income, and then dividing it by the debt service, including principal and interest. You should use the following formula. The debt carrier insurance ratio equals the internet running profits divided via way of means of the debt carrier.
Number 6 Breakeven ratio.
As per a rule of thumb, financiers will strive for an 85% or less breakeven ratio in their loans. This percentage swings and varies depending on the lender and the asset, but a loan to value ratio of less than 85% is considered favorable in real estate.
What this means is that your rental expenses can increase by 15%, or, alternatively, your operating income can drop by 15%, and you will still be breaking even on your investment property. That’s quite good for a piece of income producing real estate. To calculate the breakeven ratio of an investment property that you are considering buying, use the following formula. The breakeven ratio equals the sum of the operating expenses and the debt service divided by the gross income.
Number 7 Cash on cash return.
One real estate math formula that you should pay very special attention to when it comes to your own rental properties is the cash on cash return. It calculates your annual dividend return as a proportion of the entire amount of cash that you have invested in a property. You can calculate it using this formula. Cash on cash return equals the cash flow before taxes divided by the cash invested.
Number 8, price per square foot or PSF.
In real estate investing, the price per square foot is a simple metric used to compare the cost of similar properties. Only basic math is required to comprehend this calculation. Simply take the sales price and divide it by the property square footage. Use this formula. The price per square foot equals the sales price of the investment property divided by the total square footage.
Number 9, 50% rule.
When it comes to rental property expenses, excluding debt service, the 50% rule means that you should anticipate them to match 50% of your total gross income in most cases. Use the following real estate formula. The total expenses of your rental property equal 50% of the gross income.
Number 10, 70% rule.
The 70% rule is another rule of thumb that is very useful for real estate investors who want to flip a property. According to this rule, the maximum number you should spend on buying a property that you plan to flip is 70% of the after repair worth minus the expected expenditures on rehabilitation and remodeling. You ought to be able to manage all of your expenses, including purchasing and selling expenses, finance charges, holding costs, and other expenses while still leaving you with room for profit. The formula is the maximum purchase price equals 70% of the after repair value minus the rehab costs. So, guys, these are the 10 real estate math formulas for successful investments that I have for you today.