How to Calculate Simple Interest for Real Estate

A couple calculates home interest
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Calculating simple interest rates for real estate might sound complicated and scary, but it doesn't have to. Of any interest you could be calculating, it's one of the most basic. The accumulation of simple interest is an important thing to grasp if you're making a real estate investment. Making a simple calculation doesn't have to take more than five minutes, and all you really need is a pencil and a calculator.

How to Calculate Interest

Before diving into calculations, it's good to know Principal is the amount upon which interest is being earned. Rate is the interest rate in percent or decimal form and time is the time upon which interest is being earned. The basic equation you should know is:

Principal X Rate X Time = Interest Amount

For example: $100,000(Principal) X 0.08(8% Rate) X 1 Year (Time) = $8000 Interest

To get the total amount in hand at the end of bearing period, you can use this equation:

Principal X {1 + (Rate X Time)} = Total Amount

In the following calculation, it's for one year, at the end of which, we'll have the original $100,000, plus interest: $100,000 X {1 + (.08 X 1)} = $100,000 X 1.08 = $108,000

If we were to calculate for three years, we'll multiply the 8 percent rate by three, which gets us 24 percent or .24: $100,000 X {1 + .24} = $124,000.

Real Estate Investing Math for Profits

The real estate investor is used to seeing the words "due diligence" in their reading and web research. When considering whether or not to invest in a property, it's good to do your due diligence and and research things like:

  • The characteristics of the neighborhood.
  • Comparable and competitive properties on the market.
  • Competitive rentals in the area and rents being charged, if the property will be a rental paroperty.
  • The condition of the property itself.
  • The property's expected appreciation rate versus other properties being considered.
  • The property's amenities and expected demand from tenants.

It's best to take a long-term approach for most of these, as it is important to be relatively confident that the local economy or demand will not change dramatically while we own the property.

However, the other part of due diligence, and very important, is the math of property valuation and investment quality evaluation. The good news is that some of the calculations are easily done with online calculators, like mortgage payments. On the same sites you can find home equity calculators, pre-qualification calculators, and loan comparison calculators. Though these are primarily pointed at consumers, the mortgage payment calculator is used a lot to compare rental property mortgages for cash flow.

When it comes to investor calculations, there are some really useful ones for valuing a property and for evaluating the investment potential for a property.

Gross Potential Income

Gross potential income is the expected income a property will produce without deductions for expected vacancy or credit loss.

Gross Operating Income

This calculation takes into account losses due to vacancy and non-payment. Costs when units are vacant include advertising for a new tenant, doing minor maintenance, repainting and rehab for a new tenant, and management costs for a new lease.

Gross Rental Multiplier

Though not the most precise of tools, the GRM can give you a quick comparison tool to decide on whether to do a more thorough analysis.

Net Operating Income

Here we throw in the operating expenses, such as management, repairs, janitorial, etc. for our NOI. There can be a long list here, but they are only operating expenses, not depreciation or major work that must be depreciated over time.

Capitalization Rate

By using other properties' operating income and recent sold prices, the capitalization rate is determined and then applied to the property in question to determine current value based on income.

Cash Flow Before Taxes (CFBT)

We take net operating income and subtract capital cash expenditures as wellas debt service, add back loan proceeds and interest income.

Cash Flow After Taxes (CFAT)

This one is easy, as it's the CFBT with taxes subtracted. Using the owner's or investor's tax rate exposure, this calculation gets to the nitty gritty of what's left after everybody gets their cut, even Uncle Sam.

Break-Even Ratio

This ratio is relatively easy to calculate. It's as simple as adding the debt service to the operating expenses and dividing their sum by the operating income. This calculation is especially popular with lenders interested in learning when the property will have paid all expenses of operation and break out into profit for the rest of the year.

Return on Equity - Year One

This calculates the percentage return on your cash investment the first year.

Though all of these various calculations might seem intimidating, it doesn't have to be scary. Just take it step-by-step by working on learning the calculations that apply to your type of investing, and go from there.