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#### Building Wealth: Creating Passive Income With Your Investment Properties

Passive income has become a buzzword among investors, and for good reason. Earning money with minimal sustained effort is incredibly appealing,...

5 min read

Jan Wieder : Jul 24, 2024 9:15:00 AM

Managing your real estate investment is like any other type of business enterprise. It involves careful record-keeping, tracking income from your investment, and analyzing which expenses are necessary. As seasoned property managers, Powell Property Management of South Puget Sound is here with real estate math made easy to streamline these tasks, ensuring you're always on top of your financial game. You will use several real estate formulas frequently as you’re juggling various figures and verifying that your property is profitable.

The mathematical formulas you use as a real estate investor provide vital information to help you better manage your investment properties. With the information, you are in a better position to make decisions that could increase the success of your properties, such as changing rent, cutting back on expenses, or experimenting with amenities that yield additional income.

Our real estate cheat sheet will give you a brief rundown of the common property calculations you will use and why they’re critical for your decision-making process.

To calculate your cash-on-cash return formula for a residential property, divide your net operating income (NOI) by your total cash investment. Generally, your cash investment will include not only the down payment and closing costs but also renovation costs or other fees you paid to purchase the property. For a simple example, if your NOI is $20,000 and your total cash investment is $200,000, your cash-on-cash return is 10%.

Using the net operating income formula helps you understand your property's true profitability. The formula for NOI is gross operating income (GOI) minus total operating expenses. The most common operating expenses for an investment property include insurance, maintenance, and property management fees. For instance, if your GOI is $50,000 and your total operating expenses are $30,000, your NOI would be $20,000. You don’t factor interest payments or investment property depreciation into your operating costs.

The formula to determine your gross operating income (GOI) is your gross scheduled income (GSI) minus lost rental income from vacant units or non-payments. Then, add the value of additional income to the difference. For example, you may access additional revenue from public vending machines, parking spaces, or other fee-based features and amenities. If your GSI is $100,000 and you have $10,000 in vacancy losses and $5,000 in additional income, your GOI would be $95,000. This formula gives you a big-picture look at your total operation and the money it’s bringing in. It may help you decide whether to implement other “extras” to increase your revenue.

Within the gross operating income formula you will see one of the variables is the gross scheduled income (GSI). This figure informs you how much revenue your residential investment property will generate, given that all units are rented and no one defaults on their monthly payment. How to calculate gross scheduled income is fairly simple: The value of monthly rent for each unit multiplied by 12. For example, if you have 10 units each renting for $2,000 per month, your annual GSI would be $240,000.

The capitalization rate, often considered one of the most critical real estate formulas, is used by lenders and investors to determine the value of a property based on its potential income flow. From there, you can compare that property to others in the same market. Here is the cap rate formula: divide your net operating income by the market value or sale price of the property. For example, if your NOI is $100,000 and the property’s market value is $1,000,000, the cap rate is 10%.

Your price-to-rent ratio formula is stated as the purchase price of the property versus your annual rental revenue. This formula is typically used to compare your residential real estate investments and determine which ones are making the most money. For instance, if a property costs $500,000 to buy and generates $50,000 in annual rental income, the price-to-rent ratio is 10.

You can also compare your investment properties using the real estate price per square foot formula, which is basically the market value of the property divided by its square footage. Prospective landlords can use this formula to determine if a property is overpriced before investing in it. For example, if a property is valued at $1,000,000 and has 10,000 square feet, the price per square foot is $100.

Not all investment properties result in immediate income. Some are worthwhile because they have the potential to build equity and become more valuable assets in the future. To help measure those gains, you can calculate the equity build-up rate, which is the mortgage principal you paid in the first year divided by the initial cash invested in the first year. For example, if you paid $5,000 in mortgage principal and invested $50,000 in the first year, your equity build-up rate is 10%.

One thing that’s good to know is how often your property is actually in use or its occupancy rate formula, which is an important indicator of success. With that number, you can determine if changes need to be made to increase occupancy. The formula for determining your occupancy rate is simply the number of days a particular unit is occupied divided by the total number of days in the year. For instance, if a unit is occupied for 300 days in a year, the occupancy rate is about 82%.

Return on investment is a common business term found across various industries. That’s because, at the end of the day, you make investments because you expect them to return a certain value to you. Calculating the return on investment (annual returns/cost of investment) gives you an idea of how much of your initial investment into the commercial or residential property you can potentially recoup each year. For example, if you earn $150,000 annually from a property that costs $1,500,000, your ROI is 10%.

You can use the gross rent multiplier formula to figure out the market value of a rental property, which is especially useful if you intend to sell the property. However, you can also apply this calculation to a property you’re looking to buy to help determine if it’s a worthwhile investment for you. The formula for the gross rent multiplier is the property's market value divided by the gross scheduled income. For example, if a property’s market value is $600,000 and the GSI is $60,000, the gross rent multiplier is 10.

The debt service coverage ratio formula (DSCR) can be found by dividing your net operating income by your annual debt service. If the resulting ratio is below 1.0, that’s an indication you are likely to lose money each month, which could impede your access to financing. For example, if your NOI is $240,000 and your annual debt service is $200,000, your DSCR is 1.2.

The break-even ratio (BER) is useful for investors to determine the occupancy level needed to cover all operating expenses and debt service. The formula is: (Operating Expenses + Debt Service) / Gross Operating Income. A BER below 100% means that the property is generating enough income to cover its costs, whereas a BER above 100% indicates that the property is not covering its costs and may be a risky investment. For example, if your operating expenses and debt service total $90,000 and your gross operating income is $100,000, your BER is 90%.

Ready to maximize your real estate investment's potential? Understanding and applying these essential formulas is a great start. However, the complexities of property management require more than just knowledge—partner with experts who can help you every step of the way. Contact Powell Property Management today to see how our comprehensive services and local expertise can enhance your property's performance and profitability. Let's turn your real estate investments into successful ventures together.

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