• Skip to main content
  • Skip to primary sidebar
  • Skip to footer

PropertyMetrics

  • Home
  • Blog
  • Products
    • Proforma Software
    • Publisher Software
    • Courses
  • Sign In
    • Software Login
    • Courses Login
  • Contact Us
  • Build a Proforma

Last Updated on April 27, 2014 By Robert Schmidt 2 Comments

Common Real Estate Formulas You Should Know

The real estate investment industry involves a lot of math, and understanding real estate finance includes knowing a lot of formulas and ratios. Sometimes it’s easy for even the best of us to forget or confuse many real estate formulas. This post will serve as a helpful guide to common real estate formulas you should know.

Cap Rate

The capitalization rate, also just called the cap rate, is used by many investors to quickly determine what a property is worth, or to measure the performance of a property they already own. The advantage of the cap rate is that it takes into account vacancy, credit losses, other income, and operating expenses. It also doesn’t require a multi-period projection of cashflows. The disadvantages of the cap rate are that 1) It only looks at the first year of operating data, 2) It doesn’t take into account debt financing.

Cash on Cash Return

The cash on cash return measures the first year cash return of against the cash invested at the beginning of the year. The advantage of the cash on cash return is that it takes into account vacancy, credit losses, other income, operating expenses, AND debt financing (unlike the cap rate). It also is a simple formula that does not require projecting out cash flow over multiple years. The downside of using the cash on cash return is that it only takes into account one year of operating data.

Gross Rent Multiplier

The gross rent multiplier is the ratio of sales price over potential rental income (PRI). This is a simple measure that can give you an indication of value relative to market trends. The downside to this formula is that it only takes into account one year of data, and does not take into account operating expenses, debt financing, taxes, or risk.

Loan to Value

The loan to value ratio (LTV) is simply the ratio of the loan amount to the value of the property. This is a critical constraint banks face when financing a property, and ultimatey the value side of the equation is typically restricted by a third party appraisal.

Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) is expressed as net operating income (NOI) divided by total annual debt service. This is another critical constraint banks face when financing a property. Typically both the loan to value ratio and the debt service coverage ratio will be determined by a banks loan policy. These are both important formulas to know because a loan amount will almost always be limited by the lesser of the two constraints. In other words, the maximum loan amount will be limited by either LTV or DSCR.

Operating Expense Ratio

The operating expense ratio is simply the total operating expenses divided by effective gross income (EGI). This ratio is a useful measure that shows you what percentage of income is consumed by operating expenses. Looking at operating expense ratio trends over time in a multi-year analysis can sometimes reveal important trends.

Internal Rate of Return

Internal rate of return (IRR) for an investment is the percentage rate earned on each dollar invested for each period it is invested. IRR is also another term people use for interest or yield.

Net Present Value

Net present value (NPV) is an investment measure that tells an investor whether the investment is achieving a target yield at a given initial investment. NPV also quantifies the adjustment to the initial investment needed to achieve the target yield assuming everything else remains the same.

Understanding IRR, NPV, and discounted cash flow analysis is critical for real estate investors, but it’s not immediately easy to grasp. Here’s another post that will give you a more intuitive understanding of IRR and NPV, and here’s one that will give you a better grasp of discounted cash flow fundamentals.

Filed Under: Articles

Reader Interactions

Comments

  1. Sam says

    September 6, 2017 at 10:09 pm

    So much great info! Do these change if I’m investing in real estate with my IRA or other retirement account?

    Reply
  2. AccidentalRental says

    January 17, 2018 at 10:34 am

    Excellent list of RE ratios. I prefer to use NOI as a % of Net Rental Income because it simultaneously accounts for both Income and Operating Expenses. This is the best indicator of the financial health of a rental property in my opinion. The second most important ratio is the vacancy rate in my opinion. Extended vacancies can wipe out years of profit if not kept in check.

    Great article!

    Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

What is PropertyMetrics?

PropertyMetrics provides web-based software for commercial real estate analysis and presentation.

Recent Posts

  • How the Development Spread Works
  • Understanding the Texas Ratio
  • Understanding the Construction Draw Schedule
  • How The Double Net Lease Works
  • How to Calculate an Interest Reserve for a Construction Loan

WHAT OTHERS ARE SAYING

"I'm a 30+ year seasoned veteran in shopping center development. PropertyMetrics is an excellent source of information with professional grade software for analysis and presentation. I highly recommend it."
- Frank C. Guess | Barnhart Guess Properties, LLC


"PropertyMetrics is very helpful in my understanding of commercial real estate. The presentation and information provided is astute and always to the point with great clarity. PropertyMetrics is truly appreciated."
-Sheriar Khorsandian, CCIM | Osceola Partners, LLC


"I am very impressed with your product. I have to also compliment your company on clearly explaining valuation concepts to me. To put this into context, I asked my professor in my investment class last week if he knew of a way to value an income property using discounted cash flow analysis. Long story short...you guys are smarter than my professor. THANKS PropertyMetrics! "
-Jonathan Torres | College Student


"I want to compliment PropertyMetrics for providing clear and concise tools for analyzing commercial real estate. As the head of a local Taxpayers Association with a considerable amount of municipal real estate, your data provides me with the information needed to show how much current lease terms cost the town in lost revenue, making my task much easier. Thank you!"
-Jerome Scott | Taxpayers Association of Jamestown


I am a professor at NYU's real estate program and I always tell my students that PropertyMetrics has the best and most easily understood explanations of real estate concepts. Great job!!!"
-J. Weinberg, Adjunct Professor | New York University


"I want you to know how much I appreciate PropertyMetrics. As a 30 year real estate attorney focusing primarily on commercial leasing and purchase and sale of commercial properties, it is extremely helpful to see the principles I have learned and used for so many years explained so clearly."
-Jon K. Ladd | Business and Real Estate Law Group


"I am commercial real estate lender for a large regional bank and I recommend PropertyMetrics to everyone."
-Andrew Levin | Commercial Lender


"Frankly, since I have been getting your emails we have one of the best educated offices in our market!"
-William C. Colucci | Associate Real Estate Broker


"PropertyMetrics is awesome. I actually just went ranting and raving about it to a few other analysts at my company and everyone has been thanking me for referring them!"
-Richard Cadena Jr. | Analyst


"PropertyMetrics is great. Invaluable."
-Peter Knobloch | President/CEO

Footer

My Account

Software Login

Courses Login

Contact Us

Do you have questions, comments, or feedback? Drop us a line and let us know. Get in touch.

Get Our Best Content First

Solutions | Blog | Resources | Contact | Terms | Privacy

Copyright © 2021 PropertyMetrics.com

We use cookies to ensure that we give you the best experience on our website. If you continue to use this site we will assume that you are happy with it.OK