Despite what many of us would prefer, real estate does involve some math. Luckily, most of the formula’s are rather simple. So here we go with the top five real estate calculations (according to me, that is):
1. Cap Rate:
Net Operating Income/Total Price of Property
This is mostly used for valuing apartment complexes and other commercial buildings. You want to have a cap rate that is at least as good, preferably better, than comparable buildings in the area. I almost always want to be at a 10 cap rate or better. And always be sure to use real numbers, not what’s on the seller-provided pro forma.
Monthly Rent/Total Price of Property
This is a great calculation for houses and sometimes small multifamily apartments. There’s the old 2% rule (which is way too broad, it depends on the area). According to Gary Keller in The Millionaire Real Estate Investor, the national average is 0.7%. Regardless, this calculation gives you a good idea of how well a property will cash flow. It’s good to have a target rent/cost percentage for any given area.
3. Comparative Market Analysis
Unfortunately, there’s no real calculation for this. It’s mostly used for houses and it’s all about finding the most similar properties and then making adjustments so that a homeowner or investor would find each deal identical. The MLS is by far the best for this, but Zillow can work too (just don’t rely on the Zestimate).
4. Debt Service Ratio
Net Operating Income/Debt Service
This is the most important number for banks and so it is critical for getting financing. Anything under 1.0 means that you will lose money each month. Banks don’t like that (and you shouldn’t either). A 1.2 is generally the minimum you can afford.
5. Cash on Cash
Cash Flow/Cash In Deal
In the end, this is the most important number. It tells you what kind of return you are getting on your money. If you made $2000 on an investment you have $20,000 invested in, then you have a 10% cash on cash return. So don’t neglect this calculation when reviewing your business.
So in the end, they aren’t that bad. There’s certainly no advanced calculus, just a handful of helpful calculations to evaluate properties and also to know what banks will accept when searching for financing.