Understanding numbers
You don’t need to be a college calculus student to understand real estate math. In fact, most of the math you’ll need is grade-school level. This section is going to quickly touch on some of the basic concepts and math formulas you’ll need in your real estate investing career.
Net Operating Income (NOI) measures the profitability of an investment property by calculating total income minus operating expenses, excluding mortgage payments. Include income from amenities like laundry and parking, while operating expenses cover management fees, maintenance, taxes, and utilities.
Formula:
NOI = Total Property Revenue − Operating Expenses
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Example: If a property generates $120,000 in revenue and has $40,000 in expenses, the NOI is $80,000.
NOI helps investors assess a property’s income potential and compare investments, also playing a role in formulas like cap rate.
Debt service coverage ratio (DSCR)
Lenders and real estate investors use DSCR to evaluate a property’s ability to cover its debt obligations.
DSCR loans allow purchasing or refinancing a rental property without using tax returns or personal income.
DSCR = NOI / Total Debt Service, where total debt service includes loan principal and interest payments.
Lenders typically require a minimum DSCR, with a DSCR below 1.0 indicating insufficient income to cover debt.
Example: If NOI is $80,000 and total debt service is $60,000, DSCR = 1.33, meaning the property generates 1.33 times the debt obligation.
A healthy ROI is crucial for loan approval.
Cash-on-cash return (CoC)
Cash-on-cash (CoC) return helps investors assess the return on their actual cash investment in a property.
CoC Return = (NOI / Total Cash Invested) x 100
Total cash invested includes the down payment, closing costs, and any cash spent on renovations.
Example: With an NOI of $80,000 and a total cash investment of $300,000, the CoC return is 26.67%.
A higher CoC return indicates a better return on investment and lower financial risk. This metric helps investors compare opportunities based on cash investment goals.
The Capitalization Rate (Cap Rate)
The Capitalization Rate (Cap Rate) measures the potential return on an investment property by comparing its net operating income (NOI) to its market value.
Formula:
Cap Rate = (NOI / Purchase Price) x 100
For example, if a property has an NOI of $80,000 and a market value of $1,000,000, the cap rate is 8%, indicating an 8% annual return.
A higher cap rate suggests greater potential returns and helps investors compare and assess profitability across properties.
Gross rent multiplier (GRM)
GRM evaluates the relationship between a property's price and its potential rental income. It helps investors determine how many years of gross rental income would cover the property's cost.
GRM = Property Price / Gross Rental Income
Example: If a property is priced at $400,000 and the annual gross rental income is $65,000, GRM = 6.15.
A good GRM for investors typically ranges between 4 and 7.