Real Estate Math – Do You Know These Simple Formulas?
How much real estate math do you need to know if you are investing in real estate? There are computers and calculators for calculating interest rates or amortizing loans. What you need to know is a few simple formulas for determining if a property is a good investment or not.
The Real Estate Math You Don’t Need
The gross rent multiplier is one formula you don’t need. I bring it up because people are sometimes still using it, and there are better ways to estimate value. A gross rent multiplier is a crude way to put a value on a property. You decide that properties are worth 10 times annual rent or less, for example, and simply multiply the gross annual rent a building collects by ten to get your value.
There are obvious problems with this formula. You need to constantly change it to reflect interest rates, because a property might be profitable at 12 times rent when interest rates are low, but a money loser at eight times rent if the financing is expensive. Also, there are just plain different expenses for different properties, especially when some include utilities in the rent, for example. Gross rent doesn’t say much about the factor that makes a property valuable: the net income.
Real Estate Math You Need
Rental properties are bought for the income they produce, so this is what your real estate valuation should be based on. That is why your real estate math education needs to start with the how to use a capitalization rate, or “cap rate” to determine value. A cap rate is the rate of return expected by investors in a given area, or the rate of return on a property at a given price.
An example might make this clear. Take the gross income of a property and subtract all expenses, but not the loan payments. If the gross income is $76,000 per year, and the expenses are $32,000, you have net income before debt-service of $44,000. Now, to arrive at an estimate of value, you simply apply the capitalization rate to this figure.
If the normal capitalization rate is .10 (ask a real estate professional what is normal in your area), meaning investors expect a 10% return on the value of their investment, you would divide the net income of $44,000 by .10. You get $440,000 – the estimated value of the building. If the common rate is .08, meaning investors in the area expect only an 8% return, the value would be $550,000.
Simple Real Estate Math
Estimated value equals net income before debt-service divided by cap rate – this really is simple real estate math, but the tough part is getting accurate income figures. Is the seller is showing you ALL the normal expenses, and not exaggerating income? If he stopped repairing things for a year, and is showing “projected” rents, instead of actual rents collected, the income figure could be $15,000 too high. That would mean you would estimate the value at $187,000 more (.08 cap rate).
Besides verifying the figures, smart investors sometimes separate out income from vending machines and laundry machines. Suppose these sources provide $6,000 of the income. That would add $75,000 to the appraised value (.08 cap rate). Instead, you can do the appraisal without this income included, then add back the replacement cost of the machines (probably much less than $75,000).
No real estate formula is perfect, and all are only as good as the figures you plug into them. Used carefully, though, real estate appraisal using capitalization rates is the most accurate method for estimating the value of income properties. For putting a value on a single family home, you need another approach. Yes this means more real estate math to learn, but we’ll save that for another time.
'The attention to detail and professionalism that Troy and his staff brings to our contract drafting process is unmatched. It’s a rare occurrence to find a law firm that cares as much about your legal protection as you do. But, Doucet Co. LPA is that law firm."
Mr. Doucet and his staff handled two foreclosures and a related matter for me. I found everyone in his office to be professional, effective and responsive. Everything he handled for me got me the results I expected. I highly recommend Doucet Co., LPA.
As an attorney and former client of Doucet Co., LPA, I was very impressed with the representation of Troy Doucet and his firm. I would recommend him to all who face difficulty in saving their home or getting cooperation with their mortgage companies.
If you need legal assistance regarding foreclosure, I urge you to consider putting your complete trust in Doucet Gerling. They will employ their vast knowledge and expertise on your behalf and work to attain a great outcome for your individual needs and situation.
"Troy Doucet is one of the most gifted attorneys that we have ever had the pleasure of dealing with. He treated us with kindness and generosity. We were most impressed with his integrity and high sense of duty to us. If you are looking for an attorney to get the job done we highly recommend Troy Doucet. Our family can never thank him enough for getting our foreclosure problem solved."
My company has worked with multiple law firms in the past, but none have come close to matching the quality we are seeing from Doucet & Associates. If you want an attorney who has a deep understanding of both the legal system AND business, hire them – you won’t be disappointed.
"Mr. Doucet worked wonders in my case. He stood up for me when I felt overwhelmed and helpless and kept my credit rating and future intact. Thanks you so much for helping me and my family."
"My family and I would like to send a thank you with sincere gratitude for all the time, hard work, and long hours set a side daily to represent and speak on our behalf during a very challenging time in our life. Our success is a reflect of your commitment. Thank you Troy Doucet & law firm."