If you don’t know these formulas and you’re agent, broker, or even an investor—well, learn them. The plain truth is: real estate investing involves some math. There is no way around it. Luckily, it’s no trigonometry. It’s just basic arithmetic. Learn these basic formulas and you’ll be well on your way to mastering real estate math.
(Still on the fence about investing? Read this.)
Cap Rate = Net Operating Income / Total Price of Property
Use this formula to calculate the capitalization rate of apartment complexes and larger commercial buildings. Generally, your cap rate is good if it is at least as good, or better, than comparable buildings in the area and should be an 8 or higher. Use the cap rate to estimate your potential return on investment.
Remember: junk in is junk out. If you put bad or false numbers into any of these formulas, you will get false numbers out. Be sure to use verified numbers.
Example:
NOI: $30,000
Total Price: $360,000
$25,000 / $300,000 = 0.083 or an 8.3 Cap Rate
Gross Yield = Annual Rent / Total Price of Property
Use this formula to calculate the gross yield. The gross yield is the yield on an investment before taxes and expenses are deducted. This will tell you the value of rent money coming compared to the overall cost of the property. As a comparison among properties, this should only be used between similar properties. One area might have a higher rent, but also might have a higher vacancy rate.
Example:
Annual Rent: $9,000
Total Price (Purchase + Rehab): $100,000
Gross Yield = $9,000 / $100,000 = .09 or a 9% gross yield
(Stuck with a house that needs costly repairs? Take a look at this.)
Debt Service Ratio = Net Operating Income / Debt Service
Use this formula to calculate your debt service ratio. Banks calculate your debt service ratio to determine whether you qualify for financing. A bank will look at both the property’s debt service ratio and your “global” debt service ratio which includes the ratio of your entire portfolio.
This ratio should be a 1.2 or higher. Anything lower than 1.0 means you’re losing money. Which is bad.
Example:
NOI: $35,000
Annual Debt Service: $30,000
Debt Service Ratio = $35,000 / $28,000 = 1.25
Cash on Cash = Cash Flow / Cash In Deal
This formula gets you the cash-on-cash return, arguably the most important number on this list. The cash-on-cash return rate provides you with insight into the business plan for a property and the potential cash distributions over the life of the investment. Use it on any property with long-term debt borrowing. Cash-on-cash is a crucial calculation not only for valuing a property, but also for determining the kind of debt or equity structure to use when purchasing it.
Example:
Cash Flow (Net Operating Income – Debt Service): $15,000
Cash Into Deal: $45,000
Cash on Cash: $10,000 / $40,000 = .333 or 33%
Expert Jackson Cooper shares his experiences in real estate, finance, investments, and asset protection with working professionals and everyday men and women to help better his audience’s financial success and security. Jackson is a writer and real estate enthusiast, involved in the outreach team at Jensen and Company. For more tips and advice, visit with him online - Twitter - LinkedIn
