A beginner’s guide to maths in real estate investment – Part 2
Now that you’ve covered the basics of real estate maths, from Gross Scheduled Income, Occupancy, Gross & Net Operational Income, and Cash Flow, we’re confident you’re ready to take on a few more formulae. Master these, and you’ll soon be quick as a whip in recognising a good real estate deal – and who knows, you may just have some fun with maths!
Gross Rent Multiplier (GRM)
Quite simply, this is the ratio of the market value (or sale price of a property) over potential rental income (or GSI, ie: monthly rent x 12). Calculating the GRM is a quick way to determine a property’s value against market trends, to see if you’ve got a good deal in front of you. On the downside, the GRM doesn’t account for operating expenses, financing, taxes, etc, and is only applicable to one year of data.
Return on Investment (RoI)
One of the most reliable ways to recognise a good deal, the RoI is calculated by dividing the net profit of an investment (ie: gain from investment - cost) by the cost of investment. Note, as is the case with all real estate maths, the RoI is heavily influenced by the market trends and economic forces of a region. The more developed it is, the higher the price of property, and in comparison, cash flow doesn’t match up. For instance, London, being a developed city, may only yield an average of 3-4% returns, whereas properties in Dubai would fetch you nothing short of an average 7-8%, and sometimes, even up to 10% in returns.
Operating Expense Ratio (OER)
The OER is expressed as a percentage of a property’s total operating expenses against its Gross Operational Income (GOI). The OER can help you gauge the cost of operating a property in the long run; plus it can also be used to compare various properties.
Capitalisation Rate (NOI/price)
Dividing your Net Operating Income (NOI) by the property’s market value, or price, reveals the all-important capitalisation rate – or if you really want to show off your newly acquired knowledge and sound like a pro, ‘cap rate’ is the popular term you’re looking for! It’s best to steer clear of high cap rates between 15-20%; generally, the lower the rate, the higher your margin of revenue.
While these are more mathematical, analytical metrics, there are some simpler rules of thumb that real estate investors rely on to make quick decisions:
- The 1% or 2% Rule:Divide the property’s purchase price by a month’s rent, and if it’s anywhere south of 1-2%, then re think the deal – it’s generally not going to be very strong in the long run. The higher the percentage, the more revenue you’ll be cashing in; typically, 1-2% is accepted as the standard.
- The 10% Rule: An extension of the 1% rule, here, you want to calculate annual rental income by purchase price. If it’s more than 10%, you’ve got a good investment.
- The 50% Rule: Your average expenses on a rental property will usually amount to around 50% of the rent itself. Any more and you’ll be operating at a loss.