Professional Real Estate Investor Instructor

Weve all heard of ROR (Rate of Return) or ROI (Rate of Investment), but do you really understand how they apply to your investments? Along with ROR/ROI, lets look at a couple of other formulas that help quantify investments.

Those of you who have taken the Professional Real Estate class know I emphasize CADS (Cash After Debt Service) and touch on CAP Rate (Capitalization Rate) as two formulas that you need to understand when buying rental property. There is also ROE (Return on Equity) for those investors that have held assets for a long time and want to know what kind of return their equity is getting.

I thought wed take a little time to explore some of these formulas. Understanding how these formulas are calculated and what goes into them will help you better understand and analyze your investments.

ROR and ROI are the most commonly used formulas to analyze an investment. Investments from real estate, stocks, bonds and art apply ROR/ROI. ROR/ ROI are the ratio of money made (or lost) in relation to the investment made, also known as Capital. The money made will be referred to as the Return ; this can be either interest paid or profit.

The ROR/ROI Formula is: ((Return-Capital)/ Capital) = Rate of Return

Example – Invest $100,000 in real estate and a year later the property is worth $125,000. The ROR/ ROI is 25%, calculated as follows:

125,000-100,000 = 25,000/100,000 = 25%

Most of the time, Cap Rate (Capitalization Rate) is used for estimating the value of commercial income property. Cap Rate represents the projected return for one year, if you purchased the property with all cash.

The Cap Rate formula is: Operation Revenue – Operating Expense = (Net Operating Income) NOI / Sale Price

Example – Property has a NOI of $125,000 and sales price of $1,125,000.

$125,000/$1,125,000 = 11.1% Cap Rate

Cap Rate is a useful formula to know when looking at commercial/rental property; however, it doesnt take into consideration the debt, the cost of the debt or cash flow. The value of the investment and the ROR are important, but how much cash is going into the bank every month is a big factor. The formula used to find that out is CADS. CADS uses actual income (not scheduled), all operating expenses and the cost of Debt Service (cost of loan payments).

The CADS formula is: Operating Revenue – Operating Expense = NOI – Debt Service= CADS

Example – A 6 unit apartment building with Operating Revenue is $3,600, Operating Expense is $1,495 making NOI of $2,105 and Debt Service of $1,373 has a CADS of $732.00.

$3,600-$1,495 = $2,105-$1,373 = $732.00

Many investors who have owned investment properties for a long time have exhausted depreciation (a major tax benefit); this in turn can create a poor annual return on their equity. To figure out what the return on equity is, well use the following formula known as ROE.

The ROE formula is: Net Income/Estimated Net Equity = ROE

a) Annual gross income = monthly rent(s) times 12

b) Annual Expenses = all expenses including mortgage payment, insurance, taxes, maintenance

c) Annual Net Income = A-B

d) Estimate the Net Equity of your property: Start with the FMV (Fair Market Value) of the property (you can use one of the websites that weve worked with in class or ask your Real Estate Broker) then subtract the purchase price plus any capital improvements

Example – 12 unit apartment building:

A) Annual Rents = $216,000

B) Annual Expenses = 120,840

C) Annual Net Income = 95,160

D) Net Equity = 450,000

95,160/450,000 = 21%

These formulas are useful tools for helping define an investments value, but each individual circumstance and your personal deal boundaries also play a significant role.

Im scheduled to be on Power Trading Radio on June 29th; join us online with your questions.

Dont forget to put my next online class on your calendar – click here Professional Real Estate Investor Online Schedule .