Learn Real Estate Investing Formulas to Support Your Success
As an investor, many real estate investing formulas excel mediocre investors from advanced investors.
Formulas are necessary regularly.
Which formulas are you familiar with and use most? Today we will review several for single-family and multi-family residential evaluations. Please join us to learn more.
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It is commonly known that math is very frequently used in real estate. One of the most common phrases you’ll here is “…if the numbers make sense…”
Well, let’s take a look at how the numbers are derived and the many ways an investment can be evaluated.
We will start with single family and then proceed to multi-family.
Single-Family Residential Real Estate
As we all know, our baselines are created according to our financing terms. Keep this in mind as you review any calculations here. You may alter some calculations based upon your supportive financing. Note: Some formulas will contain abbreviations.
General Fix-n-Flip/BRRRR Offers
After evaluating the comparables and figuring out your ARV (after repair value), you’re ready to run your formula.
ARV multiplied by 0.70, minus your repair costs, equals your offer price.
Note: The percentage can be altered to whatever your financing supports. Some will be as low as 65% and others as high as 85%.
- (ARV x 0.70) – Repairs = Offer
Owner Occupant Renovation Loan Offers
For an owner occupant, after evaluating the comparables and figuring out your ARV (after repair value), you’re ready to run your formula.
In this formula we will allow a 5% equity percentage and then deduct repairs to align at an offer price.
ARV multiplied by .95, minus repair cost, equals your offer price.
- (ARV x 0.95) – Repairs = Offer
Honestly, single-family residential is quite straight forward and doesn’t have a lot of variance unless you will rent a single family home. Multi-family residential and commercial formulas have much more complexity. Multi-family properties that are 5 units or more are considered commercial.
In today’s lesson, we will keep the formulas to residential only and not other forms of non-residential commercial real estate.
This will include single-family homes that are rented and any multi-family property.
Please feel free to use these formulas accordingly.
1% Rule –
This formula is derived from the stance that the gross income of a property should not be below 1% of the purchase price in order for the investment to cash flow or be profitable. This is a common screening practice to determine an ideal purchase price.
Monthly Gross Income divided by 1% (or 0.01), equals the purchase price.
- MGI/0.01 = PP
Gross Rent Multiple (GRM) –
This formulas is derived from the stance that the purchase price of a property should not be below a desired ‘multiple’ chosen by the buyer.
The multiple is computed by using the purchase price of a property divided by the gross yearly rent. This produces the ‘multiple’.
This multiple, tells the investor how many years it would take to pay the property off, if there weren’t any other expenses or mortgage interest. A key factor to also consider, is income from other sources like parking, laundry or storage.
Purchase Price divided by Gross Yearly Rent, equals the GRM
- PP/Gross Rent = GRM
Vacancy Rate –
This data is derived from actual occupancy percentage, as it relates to turnover time between tenants. At the time a tenant moves out, to the time a new tenant moves in, is the turnover time or time the unit was vacant.
If a unit has one tenant move out on October 1st, and doesn’t have another tenant move in until November 1st, then the property was vacant 30 days out of the year (or 365 days). In this case, the property was 8.21% vacant and 91.79% occupied for the year.
The amount of days vacant, divided by 365, is the vacancy rate.
- Vacant Days/365 = Vacancy Rate
Note: You can use the same formula to find the occupancy rate.
Economic Occupancy Rate –
This is the occupancy rate as it relates to payments and not the lease. Understanding that you may have a property leased 365 days of the year, but it doesn’t mean you’ve received every payment due for all 12 months.
If a property has been occupied 12 months for the year, but has only received 11 months worth of payments (due to tenant circumstances), you’d calculate the EOR as follows.
Actual Gross Income, divided by Gross Potential Income, equals the the Economic Occupancy Rate.
- AGI/GPI = EOR
Gross Potential Income –
This is the monthly rent multiplied by 12 months of the year.
- Rent x 12 = GPI
Effective Gross Income –
This is the gross potential income minus the estimated vacancy rate. Usually a standard vacancy rate is used here, which is 5%.
First multiply the GPI by 0.05 (or 5%) to get the vacancy rate figure. Then use the formula below.
- GPI – VR = EGI
Operating Expenses –
This is the total operating expenses for the year. Operating expenses can include; taxes, insurance, property management, lawn care/snow removal, maintenance fees, trash, water, sewer, extermination, common electric, capital expenses, supplies, legal fees, salary, advertising, inspections, cleaning, reserves and accounting.
Note: Operating expenses do not include mortgage payments aka debt service.
Net Operating Income –
This is the effective gross income minus the operating expenses.
- EGI – OP EX = NOI
Debt Service –
- Mortgage x 12 = DS
This is the total mortgage payments for the year.
Cash Flow –
This is the net operating income minus the debt service.
- NOI – DS = CF
Note: This figure is before taxes.
Cash on Cash Return –
This is the total yearly cash flow divided by the down payment.
- CF/DP = CCR
Debt Service Coverage Ratio –
This is the net operating income divided by the total debt service for the year.
- NOI/DS = DSCR
Break Even Point Occupancy –
This is the point where the occupancy rate determines when you will break even, or the point before you become non-profitable.
Again, any lower occupancy then the break even point occupancy, and you become non profitable.
This formula is the total debt service and operating expenses for the year, divided by the effective gross income.
- (OP EX + DS)/EGI = BEP
Capitalization Rate or “Cap Rate” –
This formula indicates the potential rate of return that can be expected from historic trends (if applicable). Some submarkets do not have enough historic sales to create a reliable rate to expect and some submarkets do.
The formula is determined by dividing the net operating income by the purchase price.
- NOI/PP = Cap Rate
Price Per Unit/Door –
This formula is used to determine the cost per unit or “cost per door”. The formula is determined by dividing the purchase price by the total amount of units.
- PP/Units = PPU
Price Per Square Foot –
This formula is used to determine the cost per square foot. The formula is determined by dividing the purchase price by the total amount of living square footage.
- PP/SF = PPSF
Value Add Percentage –
This formula is used to determine the percent improvement to the value of the property by comparing the after repair value and the value at the point of purchase.
The formula is determined by subtracting the ARV from the original market value, and dividing that total figure by the original market value.
- (ARV – MV)/MV = VAP
Return on Investment (ROI) –
This formula is used to determine the efficiency of the investment by figuring the profitability performance. This formula directly measures the return on an investment.
The formula is determined by dividing the return on an investment, by the investments’ purchase price. Return is your profit figure.
- Net Return/Cost x 100% = ROI
As you can see there are plenty of formulas used to evaluate an investment.
From the initial screening point, to reviewing the current performance, to evaluating an exit strategy, there is much due diligence to perform to evaluate.
Use these evaluations to determine if a deal is worth pursuing and where your ideal purchase price should be.
Hopefully today’s lesson has been helpful in providing more understanding of how formulas are applied to single-family and multi-family investments.
If you are looking to understand these techniques further and want to really get educated, check out this source called Acquiring Rental Property. Its Book 2 of a 3 book series called Real Estate Knowledge Series. Its awesome at teaching all the essential skills and its very efficient and effective in its purpose.
Thanks for joining us today, faithful readers-future leaders.
Love ya and keep striving for growth.
Please comment your evaluation strategy and what formulas you use most.
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