What are the most essential formulas?

Question

What are the basic formulas for real estate investing?

Irr?

Present value of money?

What are the numbers that real estate

Investors are running all the time?

Also, is there a good book for this for beginners?

Thanks

Paul Moore · Answer

@Bob Ross.  No, in the case, the values are based on comps.  And I would recommend some of the great BP books at www.BiggerPockets.com/store.

Good luck!

Bob Ross · Answer

@Paul Moore

Thanks Paul, for now it is mostly small residential deals as a small investor.

Would you still use this formula?

Paul Moore · Answer

Hi @Bob Ross.  I would be happy to recommend a book(s), but please clarify what type of investing you are interested in - residential or commercial?  And exactly what do you want to do?

I will put forth my favorite formula in real estate:  Value = Net Operating Income ÷ Cap Rate.

The cap rate, aka the capitalization rate, is the expected rate of return for this type of asset, in this condition, at this location, at this point in time.  It often runs in the range of 5% to 8%. Here is an article on this topic.

There is a great book for commercial investors with a lot of formulas. It is called What Every Real Estate Investor Needs to Know about Cash Flow... and 36 Other Key Financial Measures by Frank Gallinelli.

I wish you the best, Bob!

Bob Ross · Answer

@Phillip Bshouty

It does, yes.  I took a real estate finance coarse in college, I remember some of the formulas being pretty in depth, though as you say,I think that was more geared to firms doing large commercial investing.  I presume most personal investors are doing more simplified calculations like you stated.

Phillip Bshouty · Answer

@Bob Ross

I haven’t seen Net Present Value used much.

You may get a variety of answers but based on my experience, when investors are looking at Return on Investment, it is understood that the return or value they get comes in a variety of different forms. And it helps to distinguish between them.

Terminology also tends to vary a bit depending on whether your dealing with a private syndication vs. publicly traded REIT.

There is the portion of the cash generated by the property that is distributed to the investors, there is the increase in equity through regular mortgage payments, and there is the potential appreciation of the property.

The pay down of mortgage debt and any appreciation in the value of the property can really only be accessed through upward refinancing in the future or through the sale of the property.

So investors often want to know the “cash-on-cash” return, which measures the amount of cash flow relative to the amount of cash that was invested in a property.

For example, an investor may invest in deal that is projected to have an 8% cash on cash return (useful info to investor in short term) and that has an overall projected average annualized rate of return of 20% per year when you factor in benefit of paying down the mortgage and a modest allowance for potential appreciation in the value of the property.

Depending on the type and size of the investment and the sophistication of the investors, some like to distinguish between cash flow generated and the actual amount distributed. In other words, what percentage of the cash generated is being paid out (as some may need to be retained for improvements to the property and or contingencies).

In short, some key metrics are cash flow, cash on cash return, overall return, debt service ratio, IRR.

If dealing with publicly traded then you’ll see terms like Funds from Operations (FFO), Adjusted Funds from Operations (AFFO), AFFO Payout Ratio.

Hope that helps.