The real estate industry has a language all its own! Getting to know the various real estate terms and what they each mean, can take awhile. In addition, real estate has several financial calculations that you might not have run across before starting your real estate investing career. That’s why we’re covering some additional real estate terms and formulas that weren’t discussed in our first post on the topic. If you didn’t read that one yet, then you can find it HERE. (link to original post on the topic)
The important thing to note about real estate formulas is that they are simply basic math calculations. The actual math is straight forward enough, it’s understanding the terms that make them appear more complicated and less intuitive initially.
Real Estate Formulas to Know
We already covered a few of the most important formulas to know in our prior post. So if you are looking for more information on ARV (after repair value), what is a CAP Rate or a MAO (maximum allowable offer), you can check that post out.
This analysis is best for looking at houses that you are planning on renting out upon completion of the work. It can allow you to compare the rent vs the cost for several properties to find which one offers you the best rate of return on the investment.
However, there are a couple of points to pay attention to:
Properties must be in “like” neighborhoods. Areas need to be similar in terms of vacancy, property types and delinquency rates. You want ratios where ratio is greater than 1% and many investors are looking for 1.7% or higher before entering into a deal.
Monthly Rent / Total Price of Property
Monthly Rent: $1,500
Total Price of Property (which is Purchase Costs + Rehab Costs): $100,000
Rent/Cost = $1,500 / $100,000 = 0.015 or a 1.5% Rent/Cost
Debt Service Ratio
If you were applying for a loan with a conventional lender, the debt service ratio is going to be critical. Traditional banks actually look at a debt service ratio for the property as well as the debt service ratio for you personally and your overall portfolio of properties (if you happen to have a portfolio).
In this calculation the lender is looking to determine if you can cover the loan payments and debt of this property as well as any other properties that you might own. If the ratio is less than 1.0, it means you aren’t able to cover everything and are actually losing money. Generally a bank underwriter is looking for a ratio of 1.2 or better in order to approve a loan. This allows for a cushion if something were to happen, you’d still be able to cover the payments to them.
Your Net Income: $50,000
Annual Debt Service: $2,000 x 12 = $24,000
Debt Service Ratio = $50,000/$24,000 = 2.08
Cash on Cash Return
Your cash on cash return (also called your “equity dividend rate” if we want to get really complicated) is fairly straightforward. It’s basically telling you what kind of return are you getting on your investment? And in the end, that rate of return is your bottom line for all the effort you put into each transaction.
To calculate this, you need to have ALL of your costs of the transaction included in the calculation. That’s purchase costs, rehab costs as well as annual expenses – anything and everything needs to be included in your costs.
Cash Flow (Net Operating Income – Debt Service): $15,000
Cash into Deal: $50,000
Cash on Cash: $15,000 / $50,000 = .3 or 30%
The 50% Rule
Next up in real estate terms to know: If you’re looking at a property to fix up and then hold onto, you need to calculate the expenses of the property to see if the deal makes sense. While creating a full analysis is something that you need to do at some point, there’s a quick and dirty way to also estimate expenses and that’s called the 50% rule.
Basically the rule says to estimate one half of your operating income for covering all of your expenses.
Operating Income: $70,000
Operating Expenses = $70,000 * 0.5 = $35,000
This analysis allows you to quickly determine if a deal has any potential. But it’s not a solid enough number to base your final decision on. So do the rest of your due diligence before moving forward!
Loan to Value Ratio
While your loan to value ratio doesn’t have anything to do with your rate of return or the costs to renovate and flip your property, it is critical to understand exactly what and how it works.
It’s important that before you even find a property that you research your financing options and determine what loan to values and interest rates are currently being offered in your market. Federal loan programs can allow you to borrow up to 97% of the appraised value of a property. However, nothing is ever is simple as it sounds. There’s a long time lag between application and approval. In addition, there are several criteria that you must meet to qualify for those loans.
Traditional banks may offer up to 90% loan to values (or LTV) for their “best” borrowers, and up to 80% for others that are approved.
It will depend upon your credit, your current income as well as your assets what loan to value lenders might offer you.
With a hard money lender like Loan Ranger Capital, our loan to values are based upon the property and the after repair value of each transaction which makes for a simpler, easier and faster loan processing and approval of your transaction.
If you would like to learn more about real estate terms or how you can quickly and easily qualify for your next loan, contact us now. At Loan Ranger Capital, we’d love to speak with you about your real estate goals and objectives! Let’s see how we can help you starting TODAY!