Real Estate Investment Math Formulas

Math formulas for evaluating Real Estate deals.

Analyst Formulas For Income Properties

Making a profit with rental real estate requires that you understand the economics of each property you buy. The math formulas presented here will help you analyze each deal on its own merits. You begin by preparing an estimate of the properties operating income and expenses for one year. Using that information, along with the properties price and financing data, you can figure the estimated return on the investment. Each formula or method has advantages and disadvantages. Using several different methods when evaluating a property will help you make better investment decisions.

When you apply for a bank loan the bank crunches the numbers. The bank looks at the cash flow compared to the loan request and determines the risk. That is what these math formulas do for you. They allow you to compare one property against another property as to which is more profitable or less risky.

For the more sophisticated evaluation methods (such as present value method) I recommend that you invest in a software program designed for the purpose. Real Data has an excellent software for that purpose.

How Much Rent To Charge

Rule of thumb: Rent = 1% of the purchase price.

This formula is a rule of thumb and is only a place to start. Ideally you have visited enough apartments and homes to know the going rents in the area where you plan to own property. I use 1% of the purchase price as a place to start when setting the rent rates because I know that I will need at least that amount to carry the property.

Another method used when setting rental rates is to look at similar apartment buildings and get the current rental rates for a similar sized unit (number of bedrooms & square footage).

A house or duplex will rent for about 1.20 or 1.35 times the apartment rent. Each part of the country is different and I recommend you come up with your own formula. You can do that by checking with several apartment complexes for the current rental rates, and compare the apartment building rents to similar sized house rental rates for the same number of bedrooms. You then divide the apartment rent ($) into the house rent ($). For example, if a two-bedroom apartment is renting for $650 per month and a two-bedroom house is renting for $850.00 per month, then take 850 divided by 650 = 1.31 - that is your rental factor for house rents vs. apartment rents in your area of town.

Cash On Cash

(Net Cash Flow (pre-tax) - Divided by Cash Invested)

Net cash flow: Dollars left after deducting interest payments and operating cost from rents received.

Cash invested: Cash down payment and cash used to get property ready to rent.

This formula will tell you what percentage of return you can expect on the cash invested. I look for a 20% return or better . A lower percentage can be acceptable to some investors because this formula does not take into account the tax advantages or appreciation gains that will increase the total overall return. Below 10% I do not even consider the investment. A figure above 20% gets serious consideration.

Gross Rent Multiplier

(Purchase Price - Divided by Annual Rent Income)

This formula will tell you how many years it would take for the rent to pay for the property. The lower the resulting number the better. The formula helps you compare one property to another similar property. A low number ( 5 or 6 ) would warn you to look for problems. For example: A bad location, the buildings age, type of tenants, deferred maintenance, high tenant turnover, etc. A high number of 10 or more may indicate a low, or negative, cash flow.

This formula is only an indicator and does not take into consideration your objectives, cash invested, taxes, appreciation, terms of the mortgage, expenses, or future rent increases. Use with care.

Total Return after Taxes

(Cash Flow After Taxes - Divided by Cash Invested)

Cash flow after taxes: Net operating cash flow - plus income tax savings - plus mortgage reduction.

This formula will show you what the total return is. A good investment would earn 15% or more. This is harder to calculate because you have to figure the buildings depreciation and any income tax savings. You are entitled to a high return because real estate lacks liquidity and your money is technically at risk.

Debt Coverage Ratio

(Net Operating Income - Divided by Annual Mortgage Payments (principal & interest)

The debt coverage ratio shows the ability of the rental income to cover the mortgage payments. Use this to compare different finance alternatives. The higher the resulting numbers, the less risk of the income not covering the mortgage payments. Lenders like a number of 1.25 or better (net income being 25% greater than Mortgage payments).

This formula is a good indicator of the properties cash flow strength. By itself the debt coverage ratio is not an indicator of the investments overall potential.

Overall Return On Total Capital

( Net Operating Income - Divide by Total Investment)

Use this to measure the productivity of an investment. This number is more accurate than the gross rent multiplier because it uses net income. The higher the resulting number the better.

The overall return on capital formula does not account for tax factors or the degree of leverage involved in the financing. It is useful when comparing the returns of various properties.

"This one thing I do well, for it is my obligation to myself"
Jim Glasgow