If you are invested in becoming a successful real estate agent or broker or are looking into buying properties, it is essential to know certain terms like the back of your hand. Familiarize yourself with terms and calculations in order to ensure speedy, accurate and thorough deals that are in your benefit. Calculations, such as cap rate, rent, gross field and more are important to know.
Rent/ Cost vs. Gross Yield
Only use the rent/cost calculation when comparing the rental value of small multifamily apartments and houses. Avoid comparing rent/cost of a property located in a war zone to that in a gated community. For example, a roof will cost the same, square foot for square foot no matter where it is located. However, vacancy and delinquency will increase in costs in a less economically stable area, implying that rent/cost will not provide an accurate cash flow estimate. While the 2% rule can discourage investors, it can be helpful. In addition, gross yield calculations are most likely used when valuing large portfolios, but they also basically serve the same value as the rent/cost calculation.
When you value an apartment complex or larger commercial buildings, it is necessary to know how to calculate the cap rate. It is also utilized for houses and multifamily homes as well. However, since operating expenses are unpredictable with most houses, you will not know how often or intense your turnover will be. Your goal is to have a cap rate that is better than comparable buildings in the neighborhood. Aim for an 8 cap rate if possible. Avoid using what is on the seller-provided pro forma.
Debt Service Ratio
Banks will always look at the property’s debt service ratio and your global debt service ratio (debt service ratio of your whole portfolio) when figuring out whether or not they should provide financing. Banks are not in favor of anything under 1.0 because it means that you will lose money each month. In general, they prefer to see a 1.2 ratio and above, allowing you a cushion to afford payments in the event that things worsen.
Cash on Cash
Cash on Cash calculations are important because they tell you the kind of return that you are getting. This is an essential calculation when valuing property as well as when evaluating the kind of debt or equity structure to utilize when buying.