If you hate math, real estate investing may not be much fun. As we've said, its a business and as such you’ll be needing to crunch some numbers. Below are simple formulas you can use to figure out the answers to the most common investment math questions. Make sure you look at our page entitled “Common Terms Explained” to get an explanation of what information the various formulas provides you.
GROSS POTENTIAL INCOME (GPI)
If you want to know what kind of income you’d receive if your rental was fully occupied and all the rent collected, you would be asking to know your GPI. To calculate simply:
# of units x rent/month x 12 months = GPI
- FYI:
This calculation assumes no vacancy and all rent paid.
If you have multiple units at varying rent you do each unit separately and add up the totals.
GROSS OPERATING INCOME (GOI)
This calculation takes GPI and factors in vacancy and non-payment of rent as a loss against income. Your real estate pro or property management specialist may be your best source for this figure. Generally this figure is in the .05 to .15 range and can vary greatly due to market conditions and location of the property. To calculate:
GPI x % of loss due to vacancy/non-payment = x
GPI – x = GOI
- FYI:
GOI is best used to narrow down candidates when looking at a number of properties. The number itself is missing too many important variables to be of greater use.
NET OPERATIING INCOME (NOI)
NOI starts giving you viable data needed in your purchase decision. This calculation adds in operating expenses associated with rental property. See our page itemizing operating expenses to plug into this calculation. The basic formula is below:
GOI – annual expenses = Net Operating Income
- FYI:
Be sure to include all the operating expenses. The old garbage in garbage out rule will hurt you.
This figure will play a big role in determining CAP rate and thus important when determining a final purchase price.
CAPITALIZATION RATE (cap rate)
As we've mentioned, CAP rate is an important calculation in determining the actual value of a property from an investor's point of view. The seller wants a low cap rate and the buyer/investor wants a high one. As an investor you probably want the CAP rate to be above 6%. In the current market (3/2009) we are seeing rates as high as 18%. We caution buyers to not just look at the CAP rate. Location, rentability, repair costs and current vacancy are important factors too. To determine CAP rate simply:
NOI / Property Value or Listing Price
You can use CAP rate to determine your offering price by adjusting the "listing price" in the formula until you get a favorable CAP rate.
