Understanding the real estate investing terms and formulas is extremely helpful (if not crucial) for brokers, agents and investors who want to service or acquire real estate investment properties.

This is not always the case, though. During my thirty-year experience as an investment real estate specialist I often encountered far too many that had no idea, and it showed – both in their performance and success rate.

As a result, I felt it needful to list what I deem are the top 20 real estate investing terms and formulas worth understanding categorized as either primary or secondary. The primary terms and formulas are the very least you should know, and the secondary terms takes it a step further for those of you who are seriously planning to become more actively engaged with real estate investing.

Primary

1. Gross Scheduled Income (GSI)

The annual rental income a property would generate if 100% of all space were rented and all rents collected. GSI does not regard vacancy or credit losses, and instead, would include a reasonable market rent for those units that might be vacant at the time of a real estate analysis.

Annual Current Rental Income

+ Annual Market Rental Income for Vacant Units

= Gross Scheduled Income

2. Gross Operating Income (GOI)

This is gross scheduled income less vacancy and credit loss, plus income derived from other sources such as coin-operated laundry facilities. Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.

Gross Scheduled Income

– Vacancy and Credit Loss

+ Other Income

= Gross Operating Income

3. Operating Expenses

These include those costs associated with keeping a property operational and in service such as property taxes, insurance, utilities, and routine maintenance; but should not be mistaken to also include payments made for mortgages, capital expenditures or income taxes.

4. Net Operating Income (NOI)

This is a property’s income after being reduced by vacancy and credit loss and all operating expenses. NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property’s market value – that is, the price a real estate investor is willing to pay for that income stream.

Gross Operating Income

– Operating Expenses

= Net Operating Income

5. Cash Flow Before Tax (CFBT)

This is the number of dollars a property generates in a given year after all cash outflows are subtracted from cash inflows but in turn still subject to the real estate investor’s income tax liability.

Net Operating Income

– Debt Service

– Capital Expenditures

= Cash Flow Before Tax

6. Gross Rent Multiplier (GRM)

A simple method used by analysts to determine a rental income property’s market value based upon its gross scheduled income. You would first calculate the GRM using the market value at which other properties sold and then apply that GRM to determine the market value for your own property.

Market Value

÷ Gross Scheduled Income

= Gross Rent Multiplier

Then,

Gross Scheduled Income

x Gross Rent Multiplier

= Market Value

7. Cap Rate

This popular return expresses the ratio between a rental property’s value and its net operating income. The cap rate formula commonly serves two useful real estate investing purposes: To calculate a property’s cap rate, or by transposing the formula, to calculate a property’s reasonable estimate of value.

Net Operating Income

÷ Value

= Cap Rate

Or,

Net Operating Income

÷ Cap Rate

= Value

8. Cash on Cash Return (CoC)

The ratio between a property’s cash flow in a given year and the amount of initial capital investment required to make the acquisition (e.g., mortgage down payment and closing costs). Most investors usually look at cash-on-cash as it relates to cash flow before taxes during the first year of ownership.

Cash Flow

÷ Initial Capital Investment

= Cash on Cash Return

9. Operating Expense Ratio

This expresses the ratio between an investment real estate’s total operating expenses dollar amount to its gross operating income dollar amount. It is expressed as a percentage.

Operating Expenses

÷ Gross Operating Income

= Operating Expense Ratio

10. Debt Coverage Ratio (DCR)

A ratio that expresses the number of times annual net operating income exceeds debt service (I.e., total loan payment, including both principal and interest).

Net Operating Income

÷ Debt Service

= Debt Coverage Ratio

DCR results,

Less than 1.0 – not enough NOI to cover the debt

Exactly 1.0 – just enough NOI to cover the debt

Greater than 1.0 – more than enough NOI to cover the debt

11. Break-Even Ratio (BER)

A ratio some lenders calculate to gauge the proportion between the money going out to the money coming so they can estimate how vulnerable a property is to defaulting on its debt if rental income declines. BER reveals the percent of income consumed by the estimated expenses.

(Operating Expense + Debt Service)

÷ Gross Operating Income

= Break-Even Ratio

BER results,

Less than 100% – less consuming expenses than income

Greater than 100% – more consuming expenses than income

12. Loan to Value (LTV)

This measures what percentage of a property’s appraised value or selling price (whichever is less) is attributable to financing. A higher LTV benefits real estate investors with greater leverage, whereas lenders regard a higher LTV as a greater financial risk.

Loan Amount

÷ Lesser of Appraised Value or Selling Price

= Loan to Value

Secondary

13. Depreciation (Cost Recovery)

The amount of tax deduction investment property owners may take each year until the entire depreciable asset is written off. To calculate, you must first determine the depreciable basis by computing the portion of the asset allotted to improvements (land is not depreciable), and then amortizing that amount over the asset’s useful life as specified in the tax code: 27.5 years for residential property, and 39.0 years for nonresidential.

Property Value

x Percent Allotted to Improvements

= Depreciable Basis

Then,

Depreciable Basis

÷ Useful Life

= Depreciation Allowance (annual)

14. Mid-Month Convention

This adjusts the depreciation allowance in whatever month the asset is placed into service and whatever month it is disposed. The current tax code only allows one-half of the depreciation normally allowed for these particular months. For instance, if you buy in January, you will only get to write off 11.5 months of depreciation for that first year of ownership.

15. Taxable Income

This is the amount of revenue produced by a rental on which the owner must pay Federal income tax. Once calculated, that amount is multiplied by the investor’s marginal tax rate (I.e., state and federal combined) to arrive at the owner’s tax liability.

Net Operating Income

– Mortgage Interest

– Depreciation, Real Property

– Depreciation, Capital Additions

– Amortization, Points and Closing Costs

+ Interest Earned (e.g., property bank or mortgage escrow accounts)

= Taxable Income

Then,

Taxable Income

x Marginal Tax Rate

= Tax Liability

16. Cash Flow After Tax (CFAT)

This is the amount of spendable cash that the real estate investor makes from the investment after satisfying all required tax obligations.

Cash Flow Before Tax

– Tax Liability

= Cash Flow After Tax

17. Time Value of Money

This is the underlying assumption that money, over time, will change value. It’s an important element in real estate investing because it could suggest that the timing of receipts from the investment might be more important than the amount received.

18. Present Value (PV)

This shows what a cash flow or series of cash flows available in the future is worth in today’s dollars. PV is calculated by “discounting” future cash flows back in time using a given discount rate.

19. Future Value (FV)

This shows what a cash flow or series of cash flows will be worth at a specified time in the future. FV is calculated by “compounding” the original principal sum forward in time at a given compound rate.

20. Net Present Value (NPV)

This shows the dollar amount difference between the present value of all future cash flows using a particular discount rate – your required rate of return – and the initial cash invested to purchase those cash flows.

Present Value of all Future Cash Flows

– Initial Cash Investment

= Net Present Value

NPV results,

Negative – the required return is not met

Zero – the required return is perfectly met

Positive – the required return is met with room to spare

21. Internal Rate of Return (IRR)

This popular model creates a single discount rate whereby all future cash flows can be discounted until they equal the investor’s initial cash investment. In other words, when a series of all future cash flows is discounted at IRR that present value amount will equal the actual cash investment amount.

So You Know