10 Real Estate Calculations for Real Estate Investors
  
Despite what many of us math-allergic folk would prefer, real estate investments do require some math. You have to know your real estate metrics to succeed! What’s a good investment? What’s a bad investment? If you don’t crunch the numbers, you’ll never know.
The first calculation is the:
1. Capitalization Rate (Cap Rate)
Used for: Apartment complexes and large commercial buildings
Net operating income (NOI) / total price of the property = CAP Rate
The disadvantage is that a cap rate is only a snapshot. It says nothing about the expected growth in rents, expenses, or property value. It also says nothing about whether using leverage will increase your return.
2. Cash Flow
Used for: Rental properties
Total income – total expenses = Cash flow
When determining your total expenses, make sure to include things like:
Property taxes, Insurance, Water, Sewage, Garbage, Electricity, Property Management, General maintenance, Capital expenditures and Vacancy rate.
3. Return on Investment
Used for: Understanding how well a deal performed
Gain on investment – cost of investment / cost of investment = ROI
Return on investment is beneficial for analyzing how well a deal did in the past.
4. Rent/Cost
Used for: Single-family homes and small multifamily properties
Monthly rent / total property price = Rent/Cost
This is a great calculation for houses and, sometimes, small multifamily apartments. That being said, only use this calculation when comparing the rental value of like properties.
5. Gross Yield
Used: For large portfolios
Annual rent / total price of property = Gross Yield
This is basically the same calculation as above, but flipped around. It’s used more often when valuing large portfolios, but overall, it serves the same purpose as rent/cost.
6. Debt Service Coverage Ratio
Used: For obtaining financing
Net operating income / debt service = DCR
Banks always want to see this important number, making it critical for obtaining financing.
A debt service ratio below 1 indicates that you will lose money each month. Banks don’t like that—and you shouldn’t, either. Generally, banks want to see a 1.2 or higher ratio. That provides a little cushion to afford the payments in case things get worse.
7. Cash-on-Cash Return
Used: For buy and hold investors
Cash flow / cash in deal = Cash on Cash Return
Cash-on-cash return is also simple to calculate and tells you what your return will be in the first year of holding the property. This is a great calculation for investors who are intent on holding a property.
8. The 50 Percent Rule
Used for: Estimating property expenses
Operating income x 0.5 = probable operating expenses
This is a shorthand rule used to estimate property expenses. Whenever possible, use real numbers—i.e., the operating statement—but either way, this rule will help you filter out deals that don’t make sense.
9. The 70 Percent Rule
Used for: Determining an offer price
Offer price = (0.7 x after repair value) – rehab
The 70 percent rule helps you decide on an appropriate offer price. Always crunch the numbers down to the closing costs before actually purchasing a property. Any offer based off the 70 percent rule should be just fine—as long as your rehab estimate and after repair value estimates are correct.
10. Equity Multiple
Used for: Understanding lifetime returns
Total cash distributions / total equity invested
The equity multiple (EM) ratio helps understand total cash return over the life of an investment. This is also an income and equity metric.
The EM differs from the IRR in that it does not take into account the length of the investment period or the time value of money. Because it does not factor in discount to present value and does not take risks or other variables into account, EM should not be looked at in isolation. Paired with IRR, however, you have a powerful combination of metrics.
The most important thing to remember when running these calculations is simple: One number does not a decision make. Real estate investment analysis requires a whole suite of metrics and calculations—because every one of these numbers tells you something different. Solid positive cash flow alone doesn’t make a property worth buying.
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