Real estate investing requires understanding and mastery of at least a handful of financial measures and formulas; otherwise, the investment opportunities cannot be properly evaluated and the investment money may be lost.
So, to help you better understand real estate investing, I’ve put together a list of twenty-one measurements and formulas used in real estate investing. Some formulas are omitted because they are complex and would require a financial calculator or real estate investment software to calculate.
1. Gross Scheduled Income (GSI)
This is the total annual income for the property as if the entire space was 100% rented and all rent collected. It includes the actual rent generated by occupied units, as well as the potential rent of vacant units.
Example: $46,800
2. Vacancy and loss of credit
This is a possible loss of rental income due to vacant units or non-payment of rent by tenants.
Example: $46,800 x 0.05 = $2,340
3. Gross Operating Income (GOI)
This is gross operating income, minus vacancy and credit losses, plus income from other sources, such as coin-operated laundry facilities.
Example: $46,800 – 2,340 + 720 = $45,180
4. Operating Expenses
These are the costs associated with keeping a property in service and the stream of income. This includes property taxes, insurance, utilities, and routine maintenance, but does not include debt service, income taxes, or depreciation.
Example: $18,525
5. Net Operating Income (NOI)
Net operating income is one of the most important measures because it represents a return on the property’s purchase price and, in short, expresses an objective measure of a property’s income stream. It is gross operating income, less operating expenses.
Example: $45,180 – 18,525 = $26,655
6. Cash Flow Before Taxes (CFBT)
Pre-tax cash flow is net operating income, less debt service and capital expenditures, plus accrued interest. Represents annual cash available before consideration of income taxes.
Example: $26,655 – 19,114 = $7,541
7. Taxable profit or loss
This is net operating income, minus mortgage interest, real estate depreciation and capital additions, amortized loan points, and closing costs, plus interest earned on property bank accounts or home equity accounts. . The tax base can be both negative and positive. If it’s negative, it can protect your other income and actually result in a negative tax liability.
Example: $1,492
8. Tax Responsibility (Savings)
This is what you should pay (or save) in taxes. It is calculated by multiplying the taxable gain or loss by the investor’s tax bracket.
Example: $1492 x 0.28 = $418
9. Cash Flow After Taxes (CFAT)
This is the amount of spendable cash generated by the property after taxes. In short, it is the bottom line and is calculated by subtracting the tax liability from the pre-tax cash flow.
Example: $7,541 – 418 = $7,123
10. Gross Rent Multiplier (GRM)
This provides a simple method you can use to estimate the market value of any income property.
Formula: Price / Gross Scheduled Income = Gross Rent Multiplier
Example: $360,000 / 46,800 = 7.69
11. Capitalization Rate
The capitalization rate (as it is more commonly called) is the rate at which future income is discounted to determine its present value.
Formula: Net Operating Income / Value = Capitalization Rate
Example: $26,655 / 360,000 = 7.40%
12. Return of cash against cash
This represents the ratio of the property’s annual cash flow (usually the first year before taxes) to the amount of initial capital investment (down payment, loan fees, acquisition costs).
Formula: Cash Flow Before Taxes / Cash Invested = Cash on Cash Back
Example: $7,541 / 110,520 = 6.82%
13. Time value of money
This is the underlying assumption that money will, over time, change in value. For this reason, investment real estate should be viewed from a time value of money standpoint because the timing of receipts may be more important than the amount received.
14. Present Value (PV)
This shows how much a cash flow or series of cash flows available in the future is worth today in purchasing power. It is calculated by “discounting” future cash flows back in time using a given rate of return (ie, the discount rate).
15. Future Value (FV)
This shows what a cash flow or series of cash flows will be worth at a specific time in the future. It is calculated by “compounding” the original principal sum at a given compounding rate.
16. Net Present Value (NPV)
This discounts all future cash flows by a desired rate of return to arrive at a present value (PV) of those cash flows and then deducts it from the investor’s initial capital investment. The resulting dollar amount is either negative (yield not met), zero (yield met perfectly), or positive (yield met with room to spare).
17. Internal Rate of Return (IRR)
This model creates a single discount rate whereby all future cash flows can be discounted until they equal the investor’s initial investment.
18. List of operating expenses
This provides the ratio of the property’s total operating expenses to its gross operating income (GOI).
Formula: Operating Expenses / Gross Operating Income = Operating Expense Ratio
Example: $18,525 / 45,180 = 41.00%
19. Debt Coverage Ratio (DCR)
It is the ratio of the net operating income of the property to the annual debt service for the year. Lenders generally require a DCR of 1.2 or higher.
Formula: Net Operating Income / Annual Debt Service = Debt Coverage Ratio
Example: $26,655 / 19,114 = 1.39
20. Balance Ratio (BER)
This measures the portion of money going out against money coming in, and tells the investor how much of the gross operating profit will be consumed by all estimated expenses. The result must always be less than 100% for a project to be viable (the lower the better). Lenders typically require a BER of 85% or less.
Formula: (Operating Expenses + Debt Service) / Gross Operating Income = Break-Even Ratio
Example: ($18,525 + 19,114) / 45,180 = 83.31%
21. Loan to Value (LTV)
This measures what percentage of the property’s appraised value or sales price (whichever is less) is attributable to financing. A higher LTV means higher leverage (higher financial risk), while a lower LTV means less leverage (lower financial risk).
Formula: Loan Amount / Appraised Value or Lower Sale Price = Loan-to-Value
Example: $252,000 / 360,000 = 69.22%