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.
In order to properly manage your commercial or residential real estate in the Seattle market, certain skills and knowledge are essential. For example, there are several real estate formulas you will use frequently as you’re juggling a myriad of different figures and verifying that your property is profitable.
Real Estate Formulas for Landlords
If you’ve recently entered the Seattle real estate market, this formulas 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:
1. Cash on Cash Return
To calculate your cash on cash return for a commercial or 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 renovations costs or other fees you paid to purchase the property. Calculating cash on cash return for your various properties gives you the necessary figures to evaluate which are the most profitable.
2. Net Operating Income
Speaking of net operating income, there is another formula to calculate that figure. The formula for NOI is gross operating income (GOI) minus total operating expenses. The most common operating expenses related to an investment property include insurance, maintenance costs, and property management fees. You wouldn’t factor interest payments or investment property depreciation into your operating costs.
3. Gross Operating Income
The formula to figure out 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 be accessing additional revenue from public vending machines, parking spaces, or other fee-based features and amenities. This formula gives you a big-picture look at your total operation and the money it’s bringing in. It may also help you decide whether to implement other “extras” to increase your revenue.
4. Gross Scheduled Income
Within the gross operating income formula you will see one of the variables in 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. The formula for your annual GSI is fairly simple: The value of monthly rent for each unit multiplied by 12.
5. Capitalization Rate
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. To find the capitalization rate, divide your net operating income by the market value or sale price of the property.
6. Price to Rent Ratio
Your price to rent ratio 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.
7. Price Per Square Foot
You can also compare your commercial investment properties using the price-per-square-foot formula, which is basically the market value of the property divided by its square footage. This formula can be used by prospective landlords before investing in the property to determine if it is overpriced.
8. Equity Build-Up Rate
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.
9. Occupancy Rate
One thing that’s good to know is how often your property is actually being utilized, or its occupancy rate, 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 property is occupied divided by the total number of days in the year.
10. Return on Investment
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.
11. Gross Rent Multiplier
You can use the gross rent multiplier formula to figure out the market value of a rental property, which is especially useful if you’re intending 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 market value of the property divided by the gross scheduled income.
12. Debt Service Coverage Ratio
The debt service coverage ratio (DSCR) can be found by dividing your net operating income by your annual debt service. If the resulting ration is below 1.0, that’s an indication you are likely to lose money each month, which could impede your access to financing. Most lenders prefer ratios of 1.2 or more in order to help with financing.
How Do you Use Real Estate Formulas?
The mathematical formulas you use as a real estate investor provide you with a wealth of important 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. If you want to share the burden of successfully operating your investment properties, consider partnering with a property management company. Powell Property Management possesses the knowledge and tools to help you track the numbers related to your commercial or residential properties, as well as positively influence those numbers by increasing occupancy rates, doing regular maintenance, and enhancing the value of your Seattle properties.