This morning I was thinking about some of the terms and calculations as a real estate investor I needed to learn. You may not use all of these calculations when analyzing a deal, but understanding each of these and when to use them is very important.
They are really not in any particular order, except for the first one.
Net Operating Income (NOI) is the most important calculation to use when it comes to analyzing a multi family apartment building or purchasing a portfolio of single family homes.
Also, Debt Coverage Ration (DCR) is a calculation that banks look at very hard when they are analyzing a multifamily property.
Learn how to make these calculations forwards and backwards.
A. Net Operating Income (NOI)
NOI is a property’s income after being reduced by vacancy and credit loss and all operating expenses. NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property’s market value that is, the price a real estate investor is willing to pay for that income stream.
Gross Operating Income – Operating Expenses = Net Operating Income
B. Gross Scheduled Income (GSI)
GSI is the annual rental income a property would generate if 100% of all space were rented and all rents collected. If vacant units do exist at the time of your real estate analysis then include them at their reasonable market rent.
Rental Income (actual) + Vacant Units (at market rent) = Gross Scheduled Income
C. Gross Operating Income (GOI)
GOI is gross scheduled income less vacancy and credit loss plus income derived from other sources such as coin-operated laundry facilities. Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.
Gross Scheduled Income – Vacancy and Credit Loss + Other Income = Gross Operating Income
D. Loan to Value (LTV)
LTV measures what percentage of a property’s appraised value or selling price (whichever is less) is attributable to financing. A higher LTV benefits real estate investors with greater leverage, whereas lenders regard a higher LTV as a greater financial risk.
Loan Amount ÷ Lesser of Appraised Value or Selling Price = Loan to Value
E. Debt Coverage Ratio (DCR)
DCR is a ratio that expresses the number of times annual net operating income exceeds debt service (i.e., total loan payment, including both principal and interest).
Net Operating Income ÷ Debt Service = Debt Coverage Ratio
- Less than 1.0 – not enough NOI to cover the debt
- Exactly 1.0 – just enough NOI to cover the debt
- Greater than 1.0 – more than enough NOI to cover the debt
F. Cash on Cash Return (CoC)
CoC is the ratio between a property’s cash flow in a given year and the amount of initial capital investment required to make the acquisition (e.g., mortgage down payment and closing costs). Most investors usually look at cash-on-cash as it relates to cash flow before taxes during the first year of ownership.
Cash Flow Before Taxes ÷ Initial Capital Investment = Cash on Cash Return
G. Cap Rate
This popular return expresses the ratio between a rental property’s value and its net operating income. The cap rate formula commonly serves two useful real estate investing purposes: To calculate a property’s cap rate, or by transposing the formula, to calculate a property’s reasonable estimate of value.
Net Operating Income ÷ Market Value = Cap Rate
Net Operating Income ÷ Cap rate = Market Value
H. Time Value of Money
Time value of money is very important to consider when you invest. What is your money worth today and what will it be worth in the future if you decide to hang on to it. This the calculation you must make when you are thinking about how to spend and invest your money wisely.
Time value of money is the underlying assumption that money, over time, will change value. It’s an important element in real estate investing because it could suggest that the timing of receipts from the investment might be more important than the amount received.
To your success and your future.
Contact me if you are looking to start investing in real estate.