REAL ESTATE INVESTMENT CALCULATIONS

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Real Estate Investment Calculations

BREAK EVEN RATIO/ DEFAULT RATIO The break even ratio of a real estate investment property is expressed as a percentage. The lower the percentage the better. Debt service and operating expenses are totaled and then divided by the gross operating income. Lenders use the break-even ratio as one of their analysis methods when considering providing financing for a real estate investment property. Too high of a break-even ratio is a cautionary indicator. Here's How: 1. Determine the debt service for the property. In this case we'll assume an annual debt service of $32,000 2. Determine the annual operating expenses for the property. In this case, we'll assume that management and direct operating costs annually are $47,000. 3. Calculate the annual gross operating income of the property. We'll assume a gross operating income of $98,000 annually. 4. Add Debt Service to Operating Expenses and divide by Operating Income: $32,000 + $47,000 / $98,000 = .81 or an 81% Break-Even Ratio.

GROSS RENTAL MULTIPLIER As a real estate agent working with real estate investors, you will likely be doing quite a few market value analysis for each property finally purchased. The Gross Rental Multiplier (GRM) is easy to calculate, but isn't a very precise tool for ascertaining value. However, it is an excellent first quick value assessment tool to see if further more detailed analysis is warranted. In other words, if the GRM is way out high or low compared to recent comparable sold properties, it probably indicates a problem with the property or gross over-pricing.

Here's How: 1. Getting the GRM for recent sold properties: Market Value / Annual Gross Income = Gross Rent Multiplier (GRM) Property sold for $750,000 / $110,000 Annual Income = GRM of 6.82 2. Estimating value of property based on GRM: Let's say that you did an analysis of recent comparable sold properties and found that, like the one above, their GRM's averaged around 6.75. Now you want to approximate the value of the property being considered for purchase. You know that its gross rental income is $68,000 annually. GRM X Annual Income = Market Value 6.75 X $68,000 = $459,000 If it's listed for sale at $695,000, you might not want to waste more time in looking at it for purchase. CAPITALIZATION RATE FOR REAL ESTATE Those who invest in real estate via income-producing properties need to have a method to determine the value of a property they're considering buying. By using other properties' operating income and recent sold prices, the capitalization rate is determined and then applied to the property in question to determine current value based on income. Here's How: 1. Get the recent sold price of an income property, such as an apartment complex. Example: Six unit apartment project sold for $300,000 2. For that same apartment project, determine the net operating income, or the net rentals realized by the owners. Example: The rental income after expenses (net) is $24,000 3. Divide the net operating income by the sale price to get cap rate. Example: $24,000 / $300,000 = .08 or 8% (The Capitalization Rate)

CASH FLOW AFTER TAXES Once Cash Flow Before Taxes is determined, it's a simple matter to subtract tax liability to determine Cash Flow After Taxes. It's possible that, due to accrued losses deductible in later years, that this could actually be a positive number and be higher than the cash flow before taxes. Here's How: 1. Determine the cash flow before taxes. 2. Subtract the income tax liability, state and federal. The result is the Cash Flow After Taxes. CASH FLOW BEFORE TAXES When you work with real estate investor clients, it's important that you have the knowledge to help them determine the viability of investments. Cash flow is quite important, as it disregards the deductibility for tax purposes of expenses. A tax return tells you some things, but cash flow tells you more. Here's How: 1. Begin with the Net Operating Income of the property. 2. Subtract the money out for debt service. This is the amount spent for the entire mortgage payment, interest and principle. 3. Subtract any capital expenditures. This would be money spent for improvements on the property, whether they are deductible that year or not. This is actual cash spent. 4. Add any loan proceeds. This is the money borrowed on a loan other than the original mortgage. If you made capital improvements, but took out a loan to pay for it, put that loan amount here as an addition. 5. Add any interest earned. Should the property have loans or investments out that provide cash in as interest, add that in here. 6. You have now come to the result, which is the Cash Flow Before Taxes (CFBT) for this property. Here's the line itemization: Begin with Net Operating Income - Subtract Debt Service - Subtract Capital Improvements cash out + Add Loan Proceeds for loans to finance operations + Add back any interest earned = Cash Flow Before Taxes

NET OPERATING INCOME As a real estate professional serving investment clients, you need to be very familiar with all the methods of valuation of income properties. One of these is the calculation of Net Operating Income, as it is used with cap rate to determine the value of a property. Here's How: 1. Determine the Gross Operating Income (GOI) of the property: Gross Potential Income - Vacancy and Credit Loss = Gross Operating Income 2. Determine the operating expenses of the property. This would include expenses for management, legal and accounting, insurance, janitorial, maintenance, supplies, taxes, utilities, etc. 3. Subtract the operating expenses from the Gross Operating Income to arrive at the Net Operating Income. Using the example of a property with a gross operating income of $52,000 and operating expenses of $37,000, our net operating income would be: $52,000 - $37,000 = $15,000 Net Operating Income GROSS POTENTIAL INCOME This one is relatively simple. We want to know what income will be realized if a property is fully occupied and all rents are collected. We take number of units times annual rent for a total. Example: An apartment complex with six units. Three rent for $700 per month and the other three rent for $800 per month. Here's How: 1. 2. 3. 4. 3 units * $700/month = $2100 $2100 * 12 = $25,200 3 units * $800/month = $2400 $2400 * 12 = $28,800 VACANCY AND CREDIT LOSS Failure to anticipate the loss of rental revenue due to vacant units and nonpayment of rent will lead to lost profitability in your clients' income producing real estate investments.

In helping clients to determine the suitability of a purchase, be sure that their due diligence includes an estimate of vacancy and credit loss. You can be sure that most lenders will take this into account also. Here's How: 1. Determine an expected percentage of loss due to vacancy and non-payment by checking that of comparable properties and the recent loss experienced by the subject property. Last year's vacancy and credit loss from the subject property may have been 3% of net operating income. Other comparable properties experienced an average of 4%. Choose a value in the mix, let's say 3.60%. 2. Adjust your net operating income for next year by any anticipated rent increases. If you are anticipating a 5% increase in rent, and net operating income this year is $44,000, then: $44,000 X 1.05 = $46,200 3. Calculate the expected monetary loss for next year due to vacancy and credit losses: $46,200(net operating income) X .0360 (3.6%) loss estimate = $1663.20. COMPOUND INTEREST The "com" in compound also means a bit more "complicated. Compound interest results in interest being calculated not only on the original principal, but also interest on the accumulated interest. As a real estate agent working with real estate investing clients, if compound interest is a factor, it's important that you know how to calculate compound interest. Of course that's easy with an interest rate calculator, but there's no substitute for at least knowing the basics and the effects of compounding. Here's How: 1. Using a simple time charting method: Let's look at a $100,000 principal amount with a 6% interest rate, compounded annually for three years. Year 1 $100,000 X .06 for one year is $6000 interest.

Year 2 Now we have $106,000 X .06 for the second year is $6360 interest. Year 3 Starting with $112,360 accumulated X .06 = $6742 interest. At the end of year 3 we have $119,102. As you can see, compound interest definitely beats simple interest for return. 2. As a mathematical formula: This is a straight formula, but a bit trickier as we need to raise a number by a power. Principal X (1 + Periodic Rate) ^ Number of Periods = Future Amount $100,000 X (1 + .06) ^ 3 = Future Amount $100,000 X (1.06 x 1.06 x 1.06) = Future Amount $100,000 X 1.19 = $119,100 rounded off. GROSS OPEARTING INCOME Once we know the Gross Potential Income of a real estate investment property, we arrive at the Gross Operating Income by subtracting out the estimated annual losses due to non-payment or vacancies. Here's How: 1. Let's use our already calculated Gross Potential Income result of $54,000. This is if all units are full and all rents paid. 2. Based on experience, the current market and rental occupancies, we estimate that our losses due to vacancies and non-payment will be 5%. 3. $54,000 *.05 = $2700 4. $54,000 $2700= $51,300 for our Gross Operating Income PROFIT PERCENTAGE This calculation is the one that real estate investors hope to utilize. It is used when a property is sold for more than the purchase price. know it so that you can help clients to determine possible returns.

Here's How: 1. Subtract the purchase price from the net from the sale of the property. Example: Property is sold for $250,000 after commissions and expenses to close. It was originally purchased for $210,000. $250,000 -$210,000 = $40,000 2. Divide the profit amount by the purchase price. $40,000 $210,000 = 0.19 or 19% Profit

RETURN ON EQUITY IN FIRST YEAR Many real estate investors are involved in multiple properties and use leverage in their purchases. When deciding on the viability of an investment, one of the measures used is the expected Return on Equity in the fist year. If two properties are similar, the one which will produce the best first year return may be the better short term investment. Here's How: 1. Determine the Cash Flow After Taxes. In this case, we'll assume a CFAT of $11,000. 2. What is the cash invested as down payment or other into acquiring the property? We'll use $170,000 in this example. 3. Divide the CFAT by the cash invested: $11,000 / $170,000 = .065 or 6.5% Return on Equity RETURN ON EQUITY IN SUBSEQUENT YEARS Apart from calculating the first year return on equity, a real estate investor might want to know their return on equity as projected for future years or as experienced after the first year. This could be important, as once the property has appreciated and the mortgage has been paid down somewhat, the amount of equity invested at that point might be better used elsewhere if current return on equity is low.

Here's How: 1. Get as accurate as possible an estimate of the current or projected value of the property. For this example, we'll use $510,000 as property value. 2. Determine the mortgage payoff. For our example, let's assume that the mortgage balance is $375,000. 3. Then calculate the Cash Flow After Taxes (CFAT). We'll use $17,000. 4. Our Return on Equity is the CFAT / (Value - Payoff): $17,000 / ($510,000 - $375,000) = .126 or 12.6% is our Return on Equity. SIMPLE INTEREST This is the most basic of the interest calculations. The accumulation of simple interest will be of interest to many of your real estate investor clients. Here's How: 1. Principal X Rate X Time = Interest Amount Principal is the amount upon which interest is being earned, rate is the interest rate in percent or decimal form and time is the time upon which interest is being earned. Example: $100,000(Principal) X 0.08(8% Rate) X 1 Year (Time) = $8000 Interest 2. Principal X {1 + (Rate X Time)} = Total Amount All we're doing here is getting the total amount in hand at the end of the interest bearing period. In this first calculation, it's for one year, at the end of which, we'll have the original $100,000 + Interest. $100,000 X {1 + (.08 X 1)} = $100,000 X 1.08 = $108,000 3. Let's do that again for three years: Here we'll multiply the .08 (8%) rate times 3 years to equal .24. $100,000 X {1 + .24} = $124,000

LOAN TO VALUE RATIO Lenders will provide mortgages based on many factors, one being the loan to value ratio of the property. The type of property, whether owner occupied or investment, will usually determine different maximum allowable LTV ratios. This ratio is expressed as a percentage and is derived by dividing the mortgage amount by the lesser of the selling price or appraised value. Here's How: 1. Using the selling price or appraised value of the property, determine the available or desired down payment and the desired mortgage amount that would be needed. Home selling for $300,000, and the buyers have $40,000 available for a down payment. $300,000 - $40,000 = $260,000 desired mortgage amount. 2. Divide the mortgage amount by the selling price and convert the result to a percentage. $260,000 / $300,000 = 0.87 or 87% which is the LTV ratio. CAPITALIZATION RATE II As a real estate agent or broker working with investor clients, you'll need to understand income property valuation methods. One used frequently uses property income and the capitalization rate to determine the current value of the property for purchase consideration. Here's How: 1. Determine the net operating income of the subject property the client is considering purchasing. If it's an apartment complex, determine the net rental income after expenses. Example: A six unit apartment project yielding $30,000 net profit from rentals. 2. From recent comparable sold properties, determine the capitalization rate. 3. Divide the net operating income by the capitalization rate to get the current property value result.

Example: Assume a capitalization rate of 11%. $30,000 / .11 = $272,727 current value of the property. INCOME PROPERTY PURCHASE PRICE/VALUATION When working with real estate investor clients, agents and brokers need to be able to assist them in determining the justification for the asking price of incomeproducing properties. Knowing the asking price and the capitalization rate of comparable properties will allow you to help your client to determine the net income that will be required in order to justify the price paid. Here's How: 1. Get the capitalization rate for comparable recently-sold properties in the area. 2. Multiply the capitalization rate by the value of the property to determine the net operating income that would be needed to justify the price. Example: A cap rate for comparable apartment complexes is 12%, or .12, and asking price for the complex under purchase consideration is $300,000. $300,000 X .12 = $36,000 in net income that would be required to justify this asking price. The capitalization rate.: Serving your real estate investor clients, you'll need to be able to aid them in the valuation of income properties. A common method used, among others, is the capitalization rate, or cap rate. Calculating Income Property Value Using Cap Rate and Net Income: Once your client has an income property under consideration, you can help them to see if the asking price is justified by using the current cap rate for comparable properties and the net income this property generates. Determine Property Income that Justifies the Asking Price: If your client knows the asking price of a property and the current cap rate for similar properties, you can calculate the net rental incomes necessary to justify the asking price. Know the calculations with capitalization rate to properly serve your investors.: Real estate investing has enough risk without your clients taking on more by purchasing over-valued income producing properties. Part of your value as a real estate agent or broker is to assist them in determining the true value of a property.

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