How To Calculate Simple Interest for the Real Estate Investor
This is the most basic of the interest calculations. The accumulation of simple interest will be of interest to many of your real estate investor clients.
Difficulty: Easy
Time Required: Five minutes
Here's How:
- Principal X Rate X Time = Interest AmountPrincipal 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. Example:
- $100,000(Principal) X 0.08(8% Rate) X 1 Year (Time) = $8000 Interest
- Principal X {1 + (Rate X Time)} = Total AmountAll we're doing here is getting the total amount in hand at the end of the interest bearing period. In this first calculation, it's for one year, at the end of which, we'll have the original $100,000 + Interest.
- $100,000 X {1 + (.08 X 1)} = $100,000 X 1.08 = $108,000
- Let's do that again for three years:Here we'll multiply the .08 (8%) rate times 3 years to equal .24.
- $100,000 X {1 + .24} = $124,000
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What You Need:
- Nothing but your pencil or a calculator.
Real Estate Investing Math for Profits
The real estate investor is used to seeing the words "due diligence" in their reading and Web research. The property related items we consider due diligence include:
- neighborhood characteristics.
- competitive properties on the market.
- if rental, competitive rentals in the area and rents being charged.
- property condition.
- expected appreciation rate versus other properties being considered.
- property amenities and expected demand from tenants.
Those are all a part of the due diligence we do when considering buying an investment property. We must take a long term approach for most of these, as we want 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.
1. Gross Potential Income
Gross potential income is the expected income a property will produce without deductions for expected vacancy or credit loss.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. Break-Even Ratio
Add Debt Service to Operating Expenses and divide by Operating Income.
This is popular with lenders. They want to know when the property will have paid all expenses of operation and break out into profit for the rest of the year.
9. Return on Equity - Year One
This is the percentage return on your cash investment the first year.
It's not scary, just start working on learning the ones that apply to your type of investing, and you'll do fine.