Commercial Real Estate Math w/ Formula’s | Vol. 2
Are you venturing into the world of commercial real estate investment? Understanding the math behind the deals is paramount for making informed decisions and maximizing returns. Whether you’re evaluating properties, analyzing cash flows, or assessing risk, having a grasp of key formulas is indispensable. Take a look at these essential commercial math formulas tailored for every investor, from novices to seasoned professionals, with practical examples to illustrate their application.
For Property Valuation & Pricing
Price/Square Foot (PSF)
Formula: PSF = Total Price / Total Square Footage
Example: A commercial property priced at $500,000 with a total square footage of 10,000 would have a PSF of $50.
Total Property Value
Formula: Total Property Value = PSF * Total Square Footage
Example: Using the previous example, the total value of the property would be $50 * 10,000 = $500,000.
Price per Unit
Formula: Price per Unit = Total Property Value / Number of Units
Example: If the property consists of 20 units, the price per unit would be $500,000 / 20 = $25,000.
For Income Analysis
Gross Rental Income (GRI)
Formula: GRI = Rent per Unit * Number of Units
Example: If each unit rents for $1,500 per month and there are 20 units, the GRI would be $1,500 * 20 = $30,000 per month.
Net Operating Income (NOI)
Formula: NOI = GRI – Operating Expenses
Example: If the GRI is $30,000 per month and operating expenses are $10,000 per month, the NOI would be $30,000 – $10,000 = $20,000 per month.
Effective Gross Income (EGI)
Formula: EGI = GRI – Vacancy and Credit Losses
Example: If the vacancy rate is 10% and there are $3,000 in credit losses per month, the EGI would be $30,000 – ($30,000 * 10%) – $3,000 = $24,000 per month.
For Financial Performance
Capitalization Rate (Cap Rate)
Formula: Cap Rate = NOI / Property Value
Example: Using the previous example with an NOI of $20,000 per month and a property value of $500,000, the Cap Rate would be $20,000 / $500,000 = 0.04 or 4%.
Return on Investment (ROI)
Formula: ROI = (Net Profit / Cost of Investment) * 100
Example: If the net profit for a property is $100,000 and the cost of investment is $1,000,000, the ROI would be ($100,000 / $1,000,000) * 100 = 10%.
Cash Flow Before Tax (CFBT)
Formula: CFBT = NOI – Debt Service
Example: If the NOI is $20,000 per month and the monthly debt service is $10,000, the CFBT would be $20,000 – $10,000 = $10,000 per month.
For Risk Assessment & Financing
Debt Service Coverage Ratio (DSCR)
Formula: DSCR = NOI / Debt Service
Example: If the NOI is $20,000 per month and the monthly debt service is $10,000, the DSCR would be $20,000 / $10,000 = 2.
Loan-to-Value Ratio (LTV)
Formula: LTV = Loan Amount / Property Value
Example: If the loan amount is $400,000 and the property value is $500,000, the LTV would be $400,000 / $500,000 = 0.8 or 80%.
Loan Payment
Formula: Loan Payment = (Loan Amount * Interest Rate) / (1 – (1 + Interest Rate)^-N)
Example: If the loan amount is $400,000, the interest rate is 5% per annum, and the loan term is 20 years (240 months), the monthly loan payment would be calculated using the formula.
For Expense Management & Analysis
Operating Expenses
Example: Property taxes, insurance, maintenance, and utilities collectively contribute to operating expenses.
Vacancy Rate
Formula: Vacancy Rate = (Vacant Units / Total Units) * 100
Example: If there are 5 vacant units out of a total of 50 units, the vacancy rate would be (5 / 50) * 100 = 10%.
Expense Ratio
Formula: Expense Ratio = Operating Expenses / Effective Gross Income
Example: If operating expenses are $100,000 per year and EGI is $150,000 per year, the expense ratio would be $100,000 / $150,000 = 0.67 or 67%.
Break-Even Occupancy Rate
Example: If operating expenses and debt service amount to $200,000 per year and EGI is $300,000 per year, the break-even occupancy rate would be calculated.
Mastering these formulas equips you with the tools to navigate the complexities of commercial real estate investing. Whether you’re analyzing potential acquisitions, managing existing properties, or securing financing, a solid understanding of these formulas will guide you towards making sound investment decisions. Remember to adapt these formulas to your specific investment goals and consult with industry professionals when needed. With diligence and knowledge, you can unlock the full potential of commercial real estate investment opportunities.
Disclaimer: VandeWeerd Commercial makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the content contained herein. Any reliance you place on such information is therefore strictly at your own risk. It does not constitute financial, investment, legal, or tax advice. Commercial real estate investment involves inherent risks, and the application of mathematical formulas alone may not guarantee investment success. Commercial real estate markets can be volatile and subject to various economic, regulatory, and environmental factors that may impact property values, rental income, and investment returns. Investors should exercise caution and perform due diligence before committing capital to any commercial real estate investment opportunity.
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