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Posted almost 2 years ago

Hate Math? 6 Easy Formulas to Analyze Investment Properties Like a Pro

Young man calculating the cost of buying a homePhoto by Towfiqu barbhuiya

If you're like most people, hearing the word “math” makes your skin crawl. But when it comes to real estate investing, quickly and accurately analyzing numbers is essential to success. Luckily, you don't need to be a math whiz to get the job done.

Today, we'll show you 6 easy formulas that will help you analyze any investment property like a pro.

So, grab your calculator and get ready to boost your real estate skills!

The Ultimate Goal: Determining ROI

First, we need to understand that a return on investment (ROI) is the goal of every real estate transaction, whether a rental property for cash flow or a buy-and-hold home for equity gains. Whatever your strategy is, ROI refers to the value you'll earn back from investing your hard-earned money into the deal.

Return on Investment = Net Profit / Total Cost

However, to calculate the ROI in real estate investments, you'll need to know a few metrics and basic formulas. Only when you master these calculations can you determine your potential ROI and adequately evaluate if the deal is worth it.

The Preparation: Operating Income and Expenses

Now, all 6 formulas we’ll eventually discuss will revolve around two values: your income and expenses. These are included in most formulas and are the building block for calculating your ROI.

Gross Operating Income

In a nutshell, the income of a property is the cash it generates on a monthly or yearly basis. Of course, this largely depends on your investment strategy:

1. Rental properties will have rent income.

2. Buy-and-hold investments will prioritize equity gains.

3. There are other ways to generate money (e.g., renting out a parking slot or garage space).

    Regardless of your plans, combine all of those income streams to have a final gross operating income:

    Gross Operating Income = (Annual Rental Income X Vacancy Rate) + All Other Income

    The rate will differ with each area and property type, so ensure that you check the comps (similar properties nearby) and research the average vacancy rate of your area. Also, note that another source of income is the appreciation rate. So, if you're planning to do long-term investment strategies, don't forget to consider this profit stream that you will gain over the years.

    Operating Expenses

    On the flip side, some costs come with owning a property. For example:

    • Property taxes & Insurance
    • Utilities
    • Maintenance
    • Management

    All of these are lumped together and called “operating expenses” of the property. Regardless if they are one-time expenses or recurring fees, everything should be included in your calculations.

    The Math Formulas: Calculating the Numbers

    So, let’s get into the actual formulas that will help you determine the potential of the investment. As always, the goal is to see if it’s worth your time and money, gaining a positive ROI in the end.

    1. Net Operating Income (NOI)

    You already have your gross operating income. Now, calculate the NOI or cash flow, which is the percentage of your gross operating income after you pay all the property expenses. The result will either be positive or negative, the latter implying you’ll continuously lose money.

    Net Operating Income = Gross Operating Income – Operating Expenses

    Generally, you want to have a positive cash flow to have a profitable investment, which is the whole point of even getting into real estate in the first place.

    2. Cash-on-Cash Return (CoC)

    While ROI measures total wealth gain, the CoC return identifies how much cash the investment property will generate compared to the investment amount. They are similar, but CoC return measures stability versus total gain.

    Cash on Cash Return = Net Operating Income / Total Cash Investment

    The CoC return is crucial when you want to borrow money from a lender to finance your investment, as it doesn’t consider the amount of borrowed money in its formula. Instead, it only looks at the actual cash you’ll invest in the property, including all one-time expenses during purchase.

    For example, if you’re buying a $300,000 value property and will borrow $200,000 for acquiring it, you’ll only include $100,000 in your CoC calculation.

    3. Capitalization Rate (Cap Rate)

    Next is the cap rate to check the investment opportunity based on the property’s market value. It doesn’t consider your method of purchasing, financing, or one-time costs for the acquisition. Instead, it helps you compare the property with others in the market, shortlist your options, and make a wise choice.

    Cap Rate = Net Operating Income / Market Value of the Property

    You should not include your mortgage payments here, should you have one. While every investor will have their own financing plans, the cap rate assumes that you’ll buy the property with cash. Making it easier for you to compare its ROI versus other properties in the market.

    There is no benchmark for a “good” cap rate, but as you sift through your options, you’ll want to choose the property that’ll give you the highest cap rate.

    4. Breakeven Ratio

    No one wants to hear the words “breakeven”—and the idea also applies to analyzing real estate opportunities. Use this formula to see if the rental property will cover its own expenses:

    Breakeven Ratio = Total Expenses / Gross Operating Income

    For example, if you have a property with a total expense of $35,000 and a gross operating income of $40,000, the breakeven ratio will be 87.5%. This means that you’ll need an occupancy rate of 87.5% or higher to at least break even on your investment.

    The higher the ratio is, the harder it’ll be for the property to cover its own expenses.

    5. Gross Rent Multiplier (GRM)

    Next is the GRM, which you’ll use to determine the ratio of the property price to annual rental income before considering any of its expenses. This number is the years it’ll take for the property to pay for itself through cash flow, so you know how long you’ll have to stay in it:

    Gross Rent Multiplier = Property Price / Gross Rental Income

    In general, investors say that a GRM between 4 to 7 is considered “healthy.” Anything above that means you’ll have difficulty paying off the property price with the rent income.

    6. One-Percent Rule (1% Rule)

    Lastly, you want to use the industry rule called the 1% Rule to see if you’ll generate a high cash flow from the property. The rule states that the monthly rent you can charge should be at least 1% of the property's total purchase price (including all the applicable expenses).

    1% of Purchase Price < Gross Monthly Rent

    Your goal is to see if the monthly rent earned will exceed the property’s monthly mortgage payment. It does not consider other costs like upkeep, insurance, and taxes.

    Good Math = Good Investments

    Keep these 6 simple calculations in your pocket, so it’s easy to weed out properties that won’t be profitable for you. As long as you know these simple formulas, you can accurately predict the future ROI of an investment opportunity and avoid any financial pitfalls that you might get yourself into.

    Don’t let math be the barrier to your investment success!

    Need more help in analyzing rental properties? Our team of expert property managers can provide the guidance you need. with us today to talk about your investment goals.



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