The Big List of Real Estate Formulas
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 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 max income that a property will produce based on the market rents. This is not a figure that’s ever based in reality.
Gross Operating Income (GOI)
GSI X Occupancy = GOI
The opposite of vacancy and what we use because our glass is half full, not half empty. If you have 85% occupancy, you’ve got 15% vacancy.
Net Operating Income (NOI)
GOI – Expenses = NOI
Don’t include your debt service aka mortgage payment in the expenses. NOI is the figure that I pay the MOST attention to when evaluating a property. How much am I gonna make?
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 = NOI – Debt Service
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.
CAP Rate = NOI / Price
Basically it’s 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 props in a certain market should expect this return.
Beware of high CAP rates (15-20%) and just because it has a decent CAP rate doesn’t 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.
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 the mutual funds and relax. If you’re doing highly leveraged deals with little cash in then 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 mortgage from the property income
Most lenders will require a minimum of 1.20. To be safe try for 1.50. At 1.00 you’re just breaking even and at .90 you’re losing money.
Internal Rate of Return (IRR)
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 – see the graphic above) it’s the required rate of return which equates the Initial Cost Outlay with the present value of series of expected cash flows. In other words IRR is the rate at which the difference between ICO and present value of cash inflows in zero.
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.
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.