Residential & Multi-Family Investing

Investment Overview

If you have extra cash and want to diversify your portfolio with real estate investment, welcome.  Contemplating about investing and not sure where to begin, you’re at the right place.  I will walk you through investing terminologies, formulas, and calculations to introduce you to the language of investing.  Or if you’re a  seasoned investor and looking for upside opportunities or buyer Return on Investment (ROI) analysis/comparison or leveraging, this page is for you as well.

Terminology

Common definitions and calculations that every investor should understand.

Common Area Maintenance

Capitalization Rate.  Rate of Return on sales price:  N.O.I. divided by sales price

N.O.I. subtract debt service

Mortgage Payments

N.O.I. divided by debt service.  Most lenders required this ratio to be at least 1.25.

Sales price X 85% divided by 27.5

Tenant signs statement stating that no verbal agreements exist between tenant and landlord applying to lease agreement.

35% of G.O.I.

Gross Operating Income: S.G.I. less vacancy

Gross Rent Multiplier – Annualized Rents/Income
Sales price divided by S.G.I.
*typically, the lower the GRM, the better because it means your rental property will take less time to pay off its price.  Good range is 4 to 7.

N.O.I divided by Debt Coverage Ratio (DCR)

Tenant pays taxes, insurance, maintenance & utilities for operating a property

Net Operating Income: S.G.I. less vacancy and expenses

Tenant pays agreed-to-percent of gross sales volume over agreed—to base sales volume

Return on Equity: Return on value of property less balances.
Cash Flow divided by Equity

Return on Investment (ROI): Rate of return on down payment. Cash flow divided by down payment.  Also, known as Cash on cash.

Scheduled Gross Income; Income before vacancy & expenses

Tenant pays increase on real property taxes

5% of S.G.I.

N.O.I. divided by Cap Rate

G.S.I. x G.R.M.

A Simple & Quick Way to Analyze Rental Properties Using Cash on Cash ROI


Quick methods to determine if a property is worth buying or what price would make sense to purchase. This will give you Cash on Cash ROI return.

1. Income

Rental
Laundry
Storage
Misc

Total Monthly Income

2. Expenses

Tax
Insurance
Utilities:

  • electric, water, sewer, garbage and gas
HOA
Lawn/Snow
Vacancy (5%)
Repairs
Capital Expenditure
Property Mgmt
Mortgage

Total Monthly Expenses

3. Cash Flow

Income - Expenses

Total Monthly Cash Flow

4. Cash on Cash ROI

What % is your money earning?

How much money was put in:

  • Down Payment, Closting costs, Rehab Budget, Misc
Total Investment

Annual Cash Flow divided by Total Investment = Cash on Cash ROI

Simple Back of the Envelope Analysis

Your rental goals might be to get financial independence, build wealth and live off the income.  These formulas analyze the rental properties to measure income and equity without using a calculator, tool, or computer.  You need to use these approaches together to determine if the property is a good investment.  Ultimately, accomplishing your financial goals.

1. Gross Rent Multiplier with 1% Rule

Gross Rent Multiplier = Sales Price divided by Total Annual Rent.

The lower the number the better at producing income. You can use this number to compare properties.  Not all properties meet the 1% rule. 

The One Percent Rule
– Rule of thumb or a shortcut or a starting point for early analysis of a property using GRM; a measurement of how good a property is at producing rental income.

Monthly Gross Rent >= 1% Sales Price (including repairs; all in costs)

2. Cap Rate - All Cash

Using Capitalization Rate or Cap Rate is more in-depth and accurate than the 1% Rule.  The cap rate is used for all-cash transactions.  The higher the cap rate, the better the return.

NOI divided by Sales Price (including repairs/total costs)

3. Net Income After Financing - With Mortgage

NIAF – Net Income After Financing
NIAF = NOI minus Financing costs

4. Cash on Cash return - With Mortgage


NIAF divided by Down Payment (includes repairs & closing costs)

4 Wealth Generators in Real Estate

The combination of these produce the return on your investment.

Cash Flow

N.O.I. subtract debt service

Extra money coming in on a rental property. The return on the cash flow.

Tax Benefits

In addition to deductions, your income (cash flow) is tax differently from regular income.

Passive Appreciation

The value of the property goes up over time.

Loan Paydown - Amortization

When the debt service is paid, the equity is added to your return on your investment.

4 Ways to Increase Equity

Buy at a Discount

Add Value (Forced Appreciation)

Pay Down Mortgage

Passive Price Appreciation

4 Ways to Increase Net Operating Income (NOI): Forced Appreciation

Raise Rent

Increase Occupancy

Decrease Expenses

Find Other Income

Putting It All Together

0 - Set Goals

1. Find a property to analyze

2. Gather Info (Rent, Expense)

3. Create Income Snapshot

  • GRM –> 1% Rule
  • Cap Rate
  • NIAF
  • C on C

4. Study Comparable Sales

5. Create Equity Snapshot

  • Current Discount
  • Potential Value Increase

CAP Rates - Why They Don't Really Matter

5 Major Downfalls of a Cap Rate Valuation

Cap Rate = NOI divided by Total Sales Price

The cap rates are one of the most widely used commercial metrics for real estate investing and real estate investment analysis. They help to give the benchmark for the property valuation.  Nevertheless, they should not be used solely because they don’t take into account other really important factors.

1. Debt

Cap rates don't take into account debt. Most real estate investments are leverage which mean they are financed.

2. Market Rent Growth

Cap rates don't take into account market rent growth. Properties in major metropolitan cities and coastal markets see much lower cap rates than mid-west cities or suburban or rural areas.

3. Capital Expenditures

Cap rates don't take into account capital expenditures. Capital expenditures are the big-ticket items such as a new roof or new appliances costs.

4. Renovation Premiums or Mark-to-Market Lease-ups

Cap rates don't take into account renovation premiums or mark-to-market lease-ups. A property with a 3% cap rate might be a great deal if the: 1. building is only 45% occupied 2. In-place rents 20% below market 3. Great property market and location In less than a year, the 3% could go to 7% within a year.

5. Sale Value

Cap rates don't take into account sale value. A property with a lower cap rate but is in an emerging growth market and strong job growth has better returns in a few years as compared to the in-verse.