How much real estate math do you need to know if you are investing in real estate? There are computers and calculators for calculating interest rates or amortizing loans. What you need to know is a few simple formulas for determining if a property is a good speculation or not.
The Real Estate Math You Don't Need
The gross rent multiplier is one formula you don't need. I bring it up because population are sometimes still using it, and there are good ways to estimate value. A gross rent multiplier is a crude way to put a value on a property. You determine that properties are worth 10 times every year rent or less, for example, and plainly multiply the gross every year rent a building collects by ten to get your value.
There are determined problems with this formula. You need to constantly convert it to reflect interest rates, because a property might be profitable at 12 times rent when interest rates are low, but a money loser at eight times rent if the financing is expensive. Also, there are just plain separate expenses for separate properties, especially when some contain utilities in the rent, for example. Gross rent doesn't say much about the factor that makes a property valuable: the net income.
Real Estate Math You Need
Rental properties are bought for the income they produce, so this is what your real estate valuation should be based on. That is why your real estate math schooling needs to start with the how to use a capitalization rate, or "cap rate" to determine value. A cap rate is the rate of return predicted by investors in a given area, or the rate of return on a property at a given price.
An example might make this clear. Take the gross income of a property and subtract all expenses, but not the loan payments. If the gross income is ,000 per year, and the expenses are ,000, you have net income before debt-service of ,000. Now, to arrive at an estimate of value, you plainly apply the capitalization rate to this figure.
If the general capitalization rate is .10 (ask a real estate expert what is general in your area), meaning investors expect a 10% return on the value of their investment, you would divide the net income of ,000 by .10. You get 0,000 - the estimated value of the building. If the tasteless rate is .08, meaning investors in the area expect only an 8% return, the value would be 0,000.
Simple Real Estate Math
Estimated value equals net income before debt-service divided by cap rate - this indeed is simple real estate math, but the tough part is getting definite income figures. Is the seeder is showing you All the general expenses, and not exaggerating income? If he stopped repairing things for a year, and is showing "projected" rents, instead of actual rents collected, the income form could be ,000 too high. That would mean you would estimate the value at 7,000 more (.08 cap rate).
Besides verifying the figures, smart investors sometimes detach out income from vending machines and laundry machines. Suppose these sources supply ,000 of the income. That would add ,000 to the appraised value (.08 cap rate). Instead, you can do the estimate without this income included, then add back the change cost of the machines (probably much less than ,000).
No real estate formula is perfect, and all are only as good as the figures you plug into them. Used carefully, though, real estate estimate using capitalization rates is the most definite formula for estimating the value of income properties. For putting a value on a singular family home, you need other approach. Yes this means more real estate math to learn, but we'll save that for other time.
Rental Homes In Tucson AZ:Real Estate Math - Do You Know These uncomplicated Formulas?