When evaluating a property that you may be considering investing in or renting, it’s important to understand different types of real estate formulas. Due to the mass volume of real estate formulas and ratios, it can be difficult to keep track of them. Here are four important real estate formulas that can be used to properly evaluate properties.

Cap Rate

The capitalization rate, usually called a cap rate, allows you to tell what the property is worth or helps you measure the performance of an already-owned property. You can calculate this rate by dividing the annual net operating income by the cost or value of the property. The advantages of using cap rate are that it takes into account vacancy, credit losses, operating expenses, and other income factors. It also doesn’t require multi-period projections so you can calculate it quickly. However, it only includes the first year of operating data and doesn’t take into account debt financing.

Cash-on-Cash Return

Cash-on-cash return is used to find the return that you receive on your equity. It’s calculated by dividing the annual cash flow before taxes by the total amount invested. The advantages and disadvantages of cash-on-cash return are the same as cap rate, plus it takes into account debt financing.

Gross Rent Multiplier

Calculating the gross rent multiplier will give you an indication of the value of the property relative to market trends. It’s calculated by dividing the price by the potential gross income. While it does give you a good indication of how good a deal is, it’s limited in its use as it doesn’t take into account factors like operating expenses, debt financing, taxes, or risk.

Operating Expense Ratio

The operating expense ratio will show you what percentage of your income will go toward operating expenses. To calculate this formula, divide the total operating expenses by the effective gross income (EGI). This formula has the potential to reveal important trends that will help you down the road.

If you’re considering investing in or renting commercial real estate, it’s important to understand certain formulas and ratios. While these aren’t the only important factors, these four calculations will help you evaluate the property that you’re considering. For full assistance in an evaluation to ensure you’re getting the right deal, come to Harkins Commercial Real Estate.