Real Estate Math - Do You Know These easy Formulas?

Homes For Rent In Lafayette La - Real Estate Math - Do You Know These easy 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 straightforward formulas for determining if a asset is a good venture or not.

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Homes For Rent In Lafayette La

The Real Estate Math You Don't Need

The gross rent multiplier is one method you don't need. I bring it up because people are sometimes still using it, and there are better ways to estimation value. A gross rent multiplier is a crude way to put a value on a property. You settle that properties are worth 10 times every year rent or less, for example, and simply multiply the gross every year 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 consist of 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 education needs to start with the how to use a capitalization rate, or "cap rate" to settle value. A cap rate is the rate of return foreseen, 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 estimation of value, you simply apply the capitalization rate to this figure.

If the general capitalization rate is .10 (ask a real estate professional what is general 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 really is straightforward real estate math, but the tough part is getting precise revenue figures. Is the wholesaler is showing you All the general 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 estimation the value at 7,000 more (.08 cap rate).

Besides verifying the figures, smart investors sometimes separate out revenue from vending machines and laundry machines. Suppose these sources furnish ,000 of the income. That would add ,000 to the appraised value (.08 cap rate). Instead, you can do the estimation without this revenue included, then add back the transfer cost of the machines (probably much less than ,000).

No real estate method is perfect, and all are only as good as the figures you plug into them. Used carefully, though, real estate estimation using capitalization rates is the most precise method for estimating the value of revenue properties. For putting a value on a particular family 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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