Real Estate Math - Do You Know These simple Formulas?

Homes For Rent - Real Estate Math - Do You Know These simple Formulas?

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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 easy formulas for determining if a asset is a good venture or not.

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The Real Estate Math You Don't Need

The gross rent multiplier is one formula you don't need. I bring it up because citizen 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 resolve 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 inevitable problems with this formula. You need to permanently change it to reflect interest rates, because a asset 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 contain utilities in the rent, for example. Gross rent doesn't say much about the factor that makes a asset valuable: the net income.

Real Estate Math You Need

Rental properties are bought for the revenue they produce, so this is what your real estate valuation should be based on. That is why your real estate math study needs to start with the how to use a capitalization rate, or "cap rate" to resolve value. A cap rate is the rate of return startling by investors in a given area, or the rate of return on a asset at a given price.

An example might make this clear. Take the gross revenue of a asset and subtract all expenses, but not the loan payments. If the gross revenue is ,000 per year, and the expenses are ,000, you have net revenue before debt-service of ,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 revenue of ,000 by .10. You get 0,000 - the estimated value of the building. If the base rate is .08, meaning investors in the area expect only an 8% return, the value would be 0,000.

Simple Real Estate Math

Estimated value equals net revenue before debt-service divided by cap rate - this certainly is easy real estate math, but the tough part is getting definite revenue figures. Is the wholesaler 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 revenue frame could be ,000 too high. That would mean you would estimate the value at 7,000 more (.08 cap rate).

Besides verifying the figures, smart investors sometimes cut off out revenue from vending machines and laundry machines. Suppose these sources supply ,000 of the income. That would add ,000 to the appraised value (.08 cap rate). Instead, you can do the estimate without this revenue included, then add back the change cost of the machines (probably much less than ,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 estimate using capitalization rates is the most definite formula for estimating the value of revenue properties. For putting a value on a singular house home, you need another approach. Yes this means more real estate math to learn, but we'll save that for another time.

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