Ignore This Math and Risk Losing Big
Real Estate Investing 101
Establishing value is one of the most important undertakings as a real estate investor. It’s real estate investing 101. A proper valuation is pivotal for investment decisions. If you are new to investing you may be unsure how to establish value and comprehend the numbers. You could very well overpay for a property. This can negatively affect your profits. If you understand how to determine value and how to positively impact that value, you can be on your way to a profitable outcome.
There are 6 key, very simple equations that you should perform to evaluate any property. We will touch on 3 of them here today, The other three will be unveiled in my next post.
Real Estate Investing 101 – Three Equations Investors Must Know
a) Operational Income = gross income – vacancy allowance
Gross income is the income generated by the property through the collection of rent, coin operated laundry, parking, etc. Vacancy loss is the possible loss of income due to units not being rented. The different between the both is your operational income.
b) Operational Expenses = insurance + taxes + repairs & maintenance + property management fees + contractor services, marketing, etc.
Operational expenses are the total of all the expenses associated with running and managing the property. The debt service (i.e. mortgage) is NOT included in this equation as it’ is not an expense generated by operating the property.
Net Operating Income (NOI) = operational income – operational expenses
The NOI is the amount of income available to service the debt after the expenses are paid. It can be a good measure of the property’s performance. It is used to determine the value of a property. If you are just learning how to invest in real estate, this is a very good tip. In order to drive up the value you need to drive up the net operating income. This can be done in two ways. Once is increasing the income and the second is decreasing the expenses.
3. The Capitalization Rate (CAP rate)= NOI / Sale price of the property
The CAP rate is an important metric in multi-family real estate. It not only measures the relationship between the income and the property’s price. It can also show how stable the property is. If you know the going CAP rate for the area, then you can also derive the property value from the NOI.
A building has an asking price of $700,000. You research that the market CAP rate for the area is 10%,, You discover in the marketing material that the NOI is $60,000. If you divide that $60,000 by the 10% CAP rate you get $600,000. The seller is asking $700,000. When you know how to invest in real estate you can see that the seller has overvalued his property.
This is an excellent tool for investors. You can see how important these equations are in determining the value of properties.
Check out my next post to learn more exciting apartment arithmetic! OK, not everyone is excited about math; but everyone likes great returns. Knowing this math can bring you passive income. And that IS exciting. It’s great for those seeking real estate investing 101 information.
In the meantime, if you want to learn more about how investing in real estate can benefit YOU, Contact us.
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