As real estate investors we’re supposed to do all sorts of calculations to make sure we’re getting a good deal. But what happens if you don’t know the real estate formulas in order to do the calculations in the first place?

Never fear as long as I am here.

Here’s my big list of real estate formulas, 2017 edition, so you too can not only see if you have a good deal but also have fun with math.

Gross Scheduled Income (GSI)
GSI = Total Monthly Rents x # Units x 12 Months

This is the annual gross rental income on a property. If you have vacancies, just back them out of the equation.

Pro Forma GSI
Pro forma GSI = Total Monthly MARKET Rents x # Units x 12 Months

This is the maximum income that a property could potentially produce based on the market rents. This is not a figure that’s ever based in reality as pro forma financial reports are based on projections not actual results.

proforma

For example, if you have a 10-unit property that is rented at $600/mo for each unit when the market rents are $700, the Realtor may try to show a pro forma GSI income statement based on the market rents instead of the actuals.

This means that right out of the gate there is a $100 a month short fall on 10 units which means you’re expecting the property to produce $1,000 a month or $12,000 a year MORE than what it actually produces.

I’ve made (and seen) a lot of income projections on properties over the years and let’s just say the actual reports are the ones we should all rely on when making our investment decisions.

Occupancy
Occupancy is the amount of rented space or units compared to the total space or units available. It is the opposite of vacancy and what we use because our glass is half full, not half empty.

If you have 85% occupancy, that means that 85% of the units are occupied and conversely, that you have a 15% vacancy rate.

I often hear excited investors bragging about 100% occupancy in their properties. I’m not that impressed with a 100% occupancy rate since to me it means that the rents are too darn low.

I had a situation once on an apartment building we were buying. The seller reported 100% occupancy and had leases to prove it.

I was confused because the rents were close to market rents and I expected a reasonable vacancy rate such as 5-10%.

Turns out that the leases were month to month, no security deposits were collected, and the seller had offered a “1st month free” rent special to fill up the units during our due diligence period.

We were stuck with close to 100% vacancy after the “free” month was up.

Best advice I have for you with regard to occupancy was first delivered by President Reagan…

Gross Operating Income (GOI)
GSI X Occupancy = GOI

As I mentioned when discussing occupancy, no professional is going to run an analysis using 100% occupancy.

When I’m calculating gross operating income, I use a factor of 5% to 15% depending on how conservative I want to be with my numbers and/or offer.

Net Operating Income (NOI)
GOI – Expenses = NOI

Net operating income is an important real estate formula because it determines both the property’s income after operating expenses and the capitalization rate or rate of return.

NOI is the figure that I pay the MOST attention to when evaluating a property.

>>> And here’s an important tip: Expenses include property taxes, insurance, and maintenance. They do not include your debt service (mortgage payment), income taxes or capital (one time) expenses.

Expense Ratio
Expense Ratio = 1 – (NOI / GSI)

This is the percentage of gross scheduled income that goes to expenses.

It’s important if you want to call bull#$*! on a seller when they claim to have a 15% expense ratio. For deals I see, this is typically around 35-40%.

Cash Flow
Cash Flow = NOI – Debt Service

This is the MOST important formula since this is our paycheck!

In this calculation the debt service just represents the mortgage payment on the property – principal and interest only.

It’s important to make sure the NOI and debt service numbers are as accurate as possible here.

A small change in interest rate or going from a 30-year loan to a 25-year loan will have a big impact on cash flow.

Capitalization aka CAP Rate
CAP Rate = NOI / Price

Basically this is the return on investment you would make if you paid cash for the property.

It’s usually expressed as a “market CAP rate” meaning that all properties of that property type in a certain market should expect this return.

As you can see from this chart, the national CAP rate trend for multifamily is pretty low even for a preferred investment like apartments.

cap rate trends

CAP rates will also vary by asset class as you can see in this chart.

cap rate by asset class

Class A typically means the property is less than 10 years old with great amenities and high end construction.

Class B typically means the property is up to 20 years old with dated amenities and construction.

Class C typically means the property is up to 30 years old with limited amenities, older construction, deferred maintenance and in need of renovation/updating. You generally will see higher CAP rates on lower class properties just because there is so much room for improvement – in more ways than one.

Beware of super high CAP rates (15-20+%) and just because a property has a decent CAP rate doesn’t always mean it will cash flow.

Some people put a lot of faith in this ratio but I personally do not.

Gross Rents Multiplier (GRM)
Price / Monthly Rent = GRM

This is a quick way to see if you have a good deal or a crappy one.

Under 100 should cash flow. Under 80 and you’ve most likely got a deal.

For example…

Purchase Price: $1,000,000
Monthly Rents: $10,000
GRM = $1,000,000/$10,000
GRM = 100
GRM = meh

Purchase Price: $1,000,000
Monthly Rents: $20,000
GRM = $1,000,000/$20,000
GRM = 50
GRM = yeah!

Return On Investment (ROI)
ROI = Annual Cash Flow/Down Payment

This is the annual return that you get from cash you put into a deal.

If you put down a big down payment and, after all your hard work, you’re only getting a 4% return then you may want to look for another strategy or just stick to mutual funds and relax.

If you’re doing highly leveraged deals with little cash in, good for you but this number may then be meaningless.

Debt Service Coverage Ratio (aka Debt Coverage Ratio DCR or DSCR)
DSCR = NOI/Annual Debt Service

The ability to pay the mortgage – principal and interest only – from the property’s net income.

Most lenders will require a minimum debt service coverage ratio of 1.20, which means that the net income (after expenses) from the property exceeds the mortgage payment by 20%.

That’s the cash cushion in these deals.

At 1.00 you’re just breaking even and at .90 you’re losing money. If your deal has a DCR of 1.50, it’s a cash cow. Congrats!

Internal Rate of Return (IRR)
NPV= ? {Period Cash Flow / (1+R)^T} – Initial Investment

Ok, you’re gonna have to travel back to business finance class with me now. This ratio is the net present value of a series of future cash flows.

I recommend using a financial calculator for this one.

Simply stated (even though there’s nothing simple about it), the IRR is the interest rate, aka discount rate, needed to bring the net present value (NPV) to zero.

That is, the interest rate that would result in the present value of the capital investment, or cash outflow, being equal to the value of the total returns over time, or cash inflow.

For example…

Initial Investment: $10,000
Cash Flow: $15,000
Term: 12 months
IRR: 50%

It’s ROI on steroids, taking into effect the time value of money AND equity accumulation, appreciation, and tax shelter.

One thing to note is that a property can have a decent IRR but still have negative cash flow during the time you own it so beware.

Here’s a simple, online IRR calculator.

Loan to Value (LTV)
LTV = Loan Amount/Lesser of Appraised Value or Purchase Price

This measures the lender’s risk. A high LTV means that there is little “skin in the game” and lenders view that as risky.

For example…

Purchase Price: $200,000
Loan Amount: $150,000
Loan to Value: 75%

A low LTV means you have a great deal of equity and/or down payment in the property and you’ll have an easier time getting approved for a mortgage loan even if you have some issues.

The lower the LTV the lower the risk from the lender’s perspective.

If a property has more than one mortgage, you may also see this expressed as CLTV or “combined loan to value.”

Most lenders offer a maximum 75% LTV on investment property financing although you’ll still find portfolio lenders who offer investment property loans as high as 95% LTV.

Cash on Cash Return (CoC)
CoC = Cash Flow (before taxes)/Initial Capital Investment

CoC is a rate of return that calculates the income earned on the cash invested in a property.

For example…

Purchase Price: $200,000
Cash Downpayment: $40,000
Annual Cash Flow: $10,000
CoC = 25%

I look for 20% CoC on my deals. I don’t always get it but that’s the goal.

Break Even Ratio (BER)
BER = (Operating Expenses + Debt Service)/Gross Operating Income

The breakeven ratio is another formula used by lenders to determine risk in a deal.

This one will show the percentage of property income the expenses are eating up.

< 100% – the property expenses are less than the income
> 100% – the property expense are more than the income

Ok, there you have it. My big, bad list of real estate calculations.

Use at your own risk. And remember to always overestimate the expenses and underestimate the income.