Updated 6 days ago on .
Sharing my reading notes - Real Estate By The Numbers
Hey everyone, I've been reading a lot of biggerpocket books and this post will be my reading notes from Real Estate By The Numbers. Hopefully this can be helpful for anyone looking to learn the basics or refresh their memory :)
CONCEPTS
1. Time Value of Money (TVM)
Definition: Money in hand is worth more than money in hand in the future.
Equation: FV = PV * (1+i)^n, where FV = future value, PV = present value, i = interest rate, or rate of return we’d expect to earn on our money if we were to receive it today and invest it immediately, and n = number of compounding periods
2. Discounted Cash Flow Analysis (DCF)
Definition: DCF gives you the present value of an entire stream of income. Used when we want to evaluate between investments to decide which one is more profitable.
Equation: DCF = (CF1 / (1+i)^1) + (CF2 / (1+i)^2) + … + (CFx / (1+i)^x)
3. Net Present Value (NPV)
Definition: Looks at the present value of all future cash flows generated by a project while considering the initial capital investment, in order to determine whether the investment will be profitable.
4. Discount Rate
This value can be difficult to approximate accurately, especially if we're not sure what we're comparing our investments to. It could be the following: 1) the rate we can earn if we invest it in another opportunity, or 2) rate we originally borrowed funds (such as HELOC) for this project, at which we are repaying the loan.
“Are the returns on the investment enough to surpass our cost of debt?”
positive NPV: gain money; negative NPV: lose money in today’s dollars
KEY RETURN METRICS
1. Table
| Metric | Short For | Equation | When to Use | Limitations |
|---|---|---|---|---|
| NOI | Net Operating Income | NOI = Gross Operating Income − Operating Expenses − Vacancy / Concessions | Used to evaluate property performance and for cap rate valuation. Also the starting point for most deal analysis. | Does not include debt service, capital expenditures, or taxes. |
| ROI | Return on Investment | ROI = (Ending Value − Starting Value) / Starting Value | Useful for understanding overall return relative to initial cash invested. | Does not account for time value of money (TVM). Two investments with the same ROI over different time periods are not equally good. |
| EM | Equity Multiplier | EM = Ending Value / Starting Value | Measures how many times your equity has grown over the life of an investment. Helpful for high-level performance comparison. | Ignores time, cash flow timing, and interim capital contributions or distributions. |
| Cap Rate | Capitalization Rate | Cap Rate = NOI / Property Value | Best for comparing properties as if purchased all-cash. Commonly used in commercial real estate valuation. | Ignores debt service, taxes, and capex. Higher cap rates often imply higher risk. Works best in efficient markets (commercial, multifamily). |
| CoC | Cash-on-Cash Return | CoC = Annual Cash Flow / Cash Invested | Best used at acquisition to measure year-1 cash flow efficiency. | Ignores appreciation, loan paydown, changing cash flows, and TVM. Not useful after major capital changes. |
| AAR | Average Annual Return | AAR = (ROI₁ + ROI₂ + … + ROIₙ) / Years Held | Gives a rough estimate of average annual performance over a hold period. | Skewed by volatility and losses. Overstates performance when returns vary significantly or include negative years. |
| CAGR | Compound Annual Growth Rate | CAGR = (Ending Value / Starting Value)^(1/n) − 1 | Best for measuring long-term growth (appreciation, rent growth) and comparing investments. | Sensitive to start/end dates. Cannot handle multiple cash inflows or outflows. |
| IRR | Internal Rate of Return | Discount rate where NPV = 0 (Excel: XIRR) | Best for projects with multiple cash flows (syndications, developments, multifamily). | Ignores project size and assumes reinvestment at the same IRR. Can be misleading if used alone. |
| ROE | Return on Equity | ROE = Annual Cash Flow / Current Equity | Useful for deciding whether to hold, refinance, or sell as equity grows. | Declines over time as equity builds. Can push investors to sell good long-term assets prematurely |
Quote from book:
"Next time you pick up a rental property, run IRR scenarios on different levels of renovation, different hold periods, and other options that may boost your returns higher than whatever your original strategy might have been. But never ignore the nonfinancial aspects of the deal either, for example, the work involved or the additional risk that might be added."
2. Example NOI and Cash Flow Before Tax calculation:
TAX RELATED CALCULATION
1. Annual Taxable Income = NOI - Mortgage Interest - Depreciation - Amortization
NOI = Income - all operating expenses
Mortgage Interest = the interest portion of each mortgage payment is deductible from NOI before determining taxable income. This number is indicated on Form 1098 issued by lender.
Depreciation = the physical structure portion of the property can depreciate over 27.5 years. Not the land portion. This portion of tax burden is pushed off until the time you sell the property, where it will be recaptured.
Amortization = tax deductions for loan costs that are taken over a period of time, as opposed to all at once.
2. Capital Gains at Sale
Cost Basis = Purchase Price + Closing Costs
For operating expenses, maintenance costs are include. Capital expenses are not deductible, instead, they will increase your cost basis. Capital expenses include large renovation items that extend the life of the property, like replacing the roof and HVAC, performing a full cosmetic renovation between tenants.
Adjusted Basis = Purchase Price + Purchase Costs + CapEx + Selling Costs (legal costs, title fees, commissions, transfer taxes) - Depreciation
Taxable Gain/Loss = Sale Price - Adjusted Basis = Depreciation Taken + Balance of Taxable Gain
Depreciation is taxed at marginal tax rate or 25%, whichever is lower.
The remainder of the taxable gain is taxed at capital gains rate, 15%
Example:
3. Tax benefits of real estate
Reduce and defer taxes can 1) boost compounded returns because we can reinvest those dollars today, 2) pay taxes in inflated dollars. A dollar today is worth less than 50 cents in 30 years.
For example, the depreciation we can deduct every year can be viewed as an interest free loan from the government between the time we save the taxes and the time we eventually have to repay them.
4. 1031 Exchange
Exchange a piece of real property for another, similar piece of property, putting off having to pay any taxes we would otherwise incur for the selling of the first property. Time between selling a property and identifying a new property is fixed.
5. Personal Residence Exclusion, Section 121
Sell your personal residence and avoid having to pay taxes on the first 250k in gains, if you owned and lived in the property for at least 2 of the previous 5 years.
"Taxes should be a key component of your deal analysis and your large investment strategy. It’s not just about how much return you can generate. It’s about how much return you can keep and reinvest."
MORTGAGE, DEBT, LEVERAGE
1. Monthly Mortgage Payment Equation
M = P x [ (r (1+r)^n / (1+r)^n) -1]
M = monthly mortgage payment
P = total loan amount
r = monthly interest rate
n = total number of payments
Interest is only paid on the outstanding principal balance of the loan.
Amortization means the proportion of mortgage payment that goes to paying down the principle/interest changes every month.
Partially amortized/Balloon loan: at the maturity date, the amortized loan ends and a lump sum of the remaining principal balance is due to pay off the loan.
2. Debt Service Coverage Ratio DSCR
Equation: DSCR = NOI / Total debt service
It measures how well an investment’s available cash flow can cover its debt obligations.
DSCR = 1, the property will break even after paying its debt.
DSCR > 1, the property should expect positive cash flow.
3. Leverage
Use borrowed capital for an investment with the intent to generate a return on the borrowed capital that will be greater than the interest paid to secure the capital.
Positive leverage: when the use of borrowed capital generates higher returns on an investment than would be attained by paying for that investment with non-borrowed funds.
Negative leverage: vice versa.
Example:
4. Cash Out Refinance
Five years into the deal, it’s better to measure cash-flow production by how much equity you have in a deal, not how much you paid out of pocket at the time of the initial purchase. The cash pulled out of a piece of real estate during refinance is nontaxable.
Example:
