Basics of Real Estate math as explained by AI

[Jimmy O'Connor]

Hey All!  

For those of you starting out, it seems like terms and equations for rental properties is like speaking another language, especially if you are not good at math. 
I typically type these guides up myself but wanted to see if the New Chat AI could produce.... spoiler alert, it can. 

Here are 5 basic equations to understand with examples as generated by the new Chat AI Robot:

1. Capitalization rate (Cap rate): The capitalization rate is used to determine the potential return on investment for a rental property. It is calculated by dividing the property's net operating income (NOI) by the purchase price (or current market value).
• Step 1: Determine the property's net operating income (NOI). This is calculated by subtracting the property's operating expenses (such as maintenance, repairs, insurance, property management fees, etc.) from the gross rental income.
• For example, if the property generates $24,000 in gross rental income per year and has operating expenses of $10,000 per year, the NOI would be $24,000 - $10,000 = $14,000.
• Step 2: Divide the NOI by the purchase price (or current market value) of the property. For example, if the property was purchased for $200,000, the cap rate would be calculated as follows: Cap rate = $14,000 / $200,000 = 7%.
  
2. Gross rental multiplier (GRM): The gross rental multiplier is a quick way to estimate the value of a rental property based on the income it generates. It is calculated by dividing the purchase price (or current market value) by the gross rental income.
• Step 1: Determine the gross rental income of the property. This is the total rent collected from tenants over a given period of time, before any expenses are deducted. For example, in this sample, the property generates $24,000 in gross rental income per year
• Step 2: Divide the purchase price (or current market value) of the property by the gross rental income. For example, if the property was purchased for $200,000, the GRM would be calculated as follows: GRM = $200,000 / $24,000 = 8.3.
  
3. Gross income multiplier (GIM): The gross income multiplier is similar to the gross rental multiplier, but it is based on the gross income of the property rather than the gross rental income. It is calculated by dividing the purchase price (or current market value) by the gross income of the property.
• Step 1: Determine the gross income of the property. This includes all income generated by the property, including rent, laundry income, parking income, etc. For this sample, the property generates $30,000 in gross income per year
• Step 2: Divide the purchase price (or current market value) of the property by the gross income. 
• For example, if the property was purchased for $300,000, the GIM would be calculated as follows: GIM = $300,000 / $30,000 = 10.
  
4. Cash on cash return: The cash on cash return is a measure of the annual return on investment for a rental property. It is calculated by dividing the annual cash flow (before taxes and depreciation) by the total cash invested in the property.
• Step 1: Determine the annual cash flow of the property. This is calculated by subtracting the annual operating expenses (including principal and interest payments on any mortgages) from the gross rental income.
• For example, if the property generates $24,000 in gross rental income per year and has operating expenses of $12,000 per year (including mortgage payments of $8,000), the annual cash flow would be $24,000 - $12,000 = $12,000.
• Step 2: Divide the annual cash flow by the total cash invested in the property. 
• For example, if the investor put down a 20% down payment ($60,000) on a $300,000 property, the cash on cash return would be calculated as follows: Cash on cash return = $12,000 / $60,000 = 20%.
  


5. Debt service coverage ratio (DSCR): The debt service coverage ratio is used to determine the ability of a rental property to generate enough income to cover its debt payments. It is calculated by dividing the net operating income (NOI) by the total debt service (principal and interest payments).
• Step 1: Determine the net operating income (NOI) of the property, as described in the example for the cap rate above.
• Step 2: Calculate the total debt service (principal and interest payments) on any mortgages for the property:
• For example, if the property has a mortgage with a principal of $200,000 and an interest rate of 4%, the total annual debt service would be $8,000 (4% of $200,000).
  

Step 3: Divide the net operating income (NOI) by the total debt service.

For example, using the numbers from the previous steps, the DSCR would be calculated as follows: DSCR = $14,000 / $8,000 = 1.75.

The debt service coverage ratio is generally expressed as a ratio or a percentage. In this example, the DSCR of 1.75 means that the property generates enough income to cover 1.75 times the amount of its debt payments. A DSCR of 1.0 or higher is generally considered to be sufficient to meet debt obligations, although some lenders may require a higher DSCR.