Episode 7 Real Estate by the Numbers

Question 1

Net worth = Total value of assets – Total value of liabilities

Answer 1

Assets are resources owned or controlled by you or your business that can be measured in dollars and will provide some future value.

Question 2

Liquid assets are assets that are easily turned into cash, such as stocks, bonds, and—of course—actual cash.

Answer 2

Appreciating assets are assets that tend to increase in value over time. Depreciating assets are assets that tend to decrease in value over time.

Question 3

Liabilities are legal debts and obligations that reduce future financial value.

Answer 3

The Personal Financial Statement (PFS) Equation: Net Worth = Assets – Liabilities

Question 4

Savings rate = Monthly income – Monthly expenses

Answer 4

Investable Assets = Liquid Assets – (3 × Monthly Expenses)

Question 5

The Balance Sheet Equation: Assets = Liabilities + Owner equity

Answer 5

The income statement (also known as the profit and loss statement) is a breakdown of revenue, expenses, and total profitability for a business or investment over a defined period of time.

Question 5

The balance sheet is a snapshot in time of everything your business owns, everything it owes, and the difference between those two numbers (which is the total value of the business).

Answer 5

Owner equity is the total value of the company to the owners.

Question 6

Income is a general term referring to the money flowing into a business or investment. Sometimes you will see income referred to as “revenue” or “sales” instead.

Answer 6

Cost of goods sold (COGS), also called cost of sales, is the direct cost to produce the goods and services sold by a company.

Question 7

Gross profit is the amount of income a company makes after subtracting the costs associated with making and selling its products and services from its total revenue. Gross profit = Income – Cost of goods sold

Answer 7

Operating expenses are the costs incurred in the normal operations of the business.

Question 8

Operating income is the amount of profit a company makes after subtracting both gross profit and operating expenses from revenue. Operating income = Gross profit – Operating expenses

Answer 8

Net income is the amount of profit a company makes after subtracting cost of goods sold, operating expenses, taxes, and interest payments from the total revenue. Net income = Operating income – Taxes – Interest

Question 9

Profit margin is the ratio of the profit a business generates to the amount of revenue brought in. The more money a business keeps in profit, the higher its profit margins. Profit margin = Profits ÷ Revenue

Answer 9

Gross profit margin is the ratio of the amount of gross profit a business generates to the amount of revenue brought in. This ratio indicates how efficiently the company is producing their products compared to their competitors.
Gross profit margin = Gross profit ÷ Revenue

Question 10

Operating profit margin is the ratio of the amount of operating income a business generates to the amount of revenue brought in. This ratio indicates how efficiently the company is operating, including both product creation and management.
Operating profit margin = Operating income ÷ Revenue

Answer 10

Net profit margin is the ratio of the amount of net income a business generates to the amount of revenue brought in. This ratio indicates how efficiently the company is operating overall.
Net profit margin = Net income ÷ Revenue

Question 11

Gross operating income (GOI) GOI = Gross potential rent – Rent loss + Other income

Answer 11

Gross potential rent Gross potential rent = Number of units × Market rent × 12

Question 12

Operating expenses (in real estate) are expenses associated with the basic functions and operations of the property, such as insurance, repairs and maintenance, and taxes.

Answer 12

Net operating income (NOI) is the gross operating income of a property minus operating expenses. NOI = Gross operating income – Operating expenses

Question 13

Cash flow is the amount of pre-tax cash a property generates. It is equal to the net operating income minus debt service and capital expenses. Cash flow = NOI – Debt service – Capital expenses

Answer 13

Interest is the periodic payment against money that is borrowed or lent.

Question 14

Simple interest Interest = Principal × Interest rate

Answer 14

Total interest Total interest = Principal × Interest rate × Number of years #31: Interest rate Interest rate = Interest ÷ Principal

Question 15

Compound interest Compound interest = (Principal × (1 + Interest rate) Periods) – Principal

Answer 15

Expected value EV = (E1 × P1) + (E2 × P2) + … + (EN × PN)
Where:
E = The expected financial result of the outcome, and
P = The probability of the outcome.

Question 16

Time value of money (TVM) is the concept that money in hand today is worth more than money in hand at some future time.

Answer 16

Future value formula FV = PV × (1 + i) n

Question 17

Discount rate is the rate of return used to discount future value (or future cash flows) back to their present value.

Answer 17

Present Value formula PV = FV ÷ (1 + i) n

Question 18

Discounted cash flow (DCF) gives you the present value of an entire stream of income.
DCF = (CF1 ÷ (1 + i)1) + (CF2 ÷ (1 + i)2) + … + (CFx ÷ (1 + i)x)
where CF is each of the future cash flows, and i is the discount rate.

Answer 18

Net present value (NPV) compares the current value of all future cash flows generated by a project while considering the initial capital investment in order to determine whether the investment will be profitable.

Question 19

Internal rate of return (IRR) is the discount rate that makes NPV = 0 for an investment; IRR is the compounded return of that investment.

Answer 19

Taxable income Taxable income = NOI – Mortgage interest – Depreciation – Amortization

Question 20

Depreciation is a tax adjustment that accounts for the declining condition of a physical property. It allows real estate investors to delay a portion of their income taxes for a given property until that property is sold.

Answer 20

Amortization refers to tax deductions against loan expenses that are taken over a period of time, as opposed to all at once.

Question 21

Basis (or “cost basis”) is the starting point for the tax liability associated with selling a property. It is generally defined as the purchase price plus any closing costs.

Answer 21

Adjusted basis is the end point for the tax liability associated with selling a property. It adjusts the “basis” by accounting for capital expenditures, sales costs, and depreciation.

Question 22

Adjusted basis formula Adjusted basis = Purchase price + Purchase costs + Capital expenditures + Selling costs – Depreciation

Answer 22

Taxable gain/Loss at sale Taxable gain/Loss at sale = Sale price – Adjusted basis

Question 23

Cash flow before taxes Cash flow before taxes = NOI – Debt service – Capital expenses + Loan additions

Answer 23

Cash flow after taxes Cash flow after taxes = Cash flow before taxes – Income tax

Question 24

Return on investment (ROI) ROI = (Ending value – Starting value) ÷ (Starting value)

Answer 24

Annualized ROI Annualized ROI = ROI ÷ Years held

Question 25

Equity multiplier (EM) EM = Ending value ÷ Starting value

Answer 25

Capitalization rate (cap rate) Cap rate = NOI ÷ Value

Question 26

Cash-on-cash return (COC) COC = Annual cash flow ÷ Cash invested

Answer 26

Average annual return (AAR) AAR = (ROI1 + ROI2 + … + ROIN) ÷ Years held

Question 27

Compound annual growth rate (CAGR) CAGR = (Ending value ÷ Starting value)(1 ÷ n) – 1 Where n = number of periods

Answer 27

Gross rent multiplier (GRM) GRM = Value ÷ Gross potential income

Question 28

Financing refers to all the capital used to purchase an asset, like a business or a real estate investment. Financing can fall into different categories (e.g., debt, equity) and can be provided or obtained from a variety of sources.

Answer 28

Preferred equity holders are given preference in the capital stack over common equity holders. Typically, they will receive returns up to a specific amount or percentage (the “preferred return”) before common equity holders receive any return. Preferred equity holders have more risk than debt holders but less risk than common equity holders.

Question 29

Debt financing involves borrowing money in the form of a loan and then repaying that money with a predefined amount of interest.

Answer 29

Principal Principal = Purchase price × (1 – Down payment %)

Question 30

Monthly mortgage payments M = P × [(r (1 + r)n ÷ ((1 + r)n) – 1]
Where:
M = monthly mortgage payment
P = total loan amount r = monthly interest rate (Divide your annual interest rate by 12. For a 5 percent interest rate,
r = 0.417 percent)
n = total number of payments (Multiply the term of your loan in years by 12. For a thirty-year mortgage, n = 360)

Answer 30

Equity value Equity value = Property value – Liabilities

Question 31

Loan-to-value ratio (LTV) LTV = Loan amount ÷ Property value

Answer 31

Loan-to-cost ratio (LTC) LTC = Loan amount ÷ All-in costs

Question 32

Debt service coverage ratio (DSCR) DSCR = Net operating income ÷ Total debt service

Answer 32

The loan constant (or mortgage constant) is a ratio that indicates the relationship between a loan and its monthly payment. The ratio (percentage) is the cash paid to service a loan in one year divided by the total amount owed on the loan. Loan constant = Annual debt service ÷ Loan amount

Question 33

Breakeven loan value is the amount you can borrow using a specific loan for a specific property where the cash flow transitions from positive to negative. Breakeven loan value = NOI ÷ Loan constant

Answer 33

Leverage (the concept) is the use of borrowed capital for an investment with the intent to generate a return on the borrowed capital that will be greater than the interest paid to secure the capital.

Question 34

Positive leverage occurs when the use of borrowed capital generates higher returns on an investment than would be attained by paying for that investment with non-borrowed funds.

Answer 34

Negative leverage occurs when the use of borrowed capital reduces the returns on an investment compared to if that investment were purchased with non-borrowed funds.

Question 35

Leverage (the value) is the difference between the cap rate of an investment and the loan constant of a particular financing option for that investment. Leverage = Cap rate – Loan constant

Answer 35

Determination of positive or negative leverage is done by looking at the Leverage value. If Leverage is a positive number (the cap rate is higher than the loan constant), the loan will provide positive leverage. If Leverage is a negative number (the cap rate is lower than the loan constant), the loan will provide negative leverage.

Question 36

Return on equity (ROE) ROE = Cash flow ÷ Equity value

Answer 36

Profit Profit = Sales price – Purchase price – Expenses
Where:
The sales price is the conservative estimate of what you can sell the property for at sale.
The purchase price is the expected cost to acquire the property.
Expenses are the expected total costs associated with buying, renovating, holding, and then reselling the property.

Question 37

Equity-on-cash return (EOC) EOC = Annual principal paydown ÷ Cash invested #77: Annual depreciation Annual depreciation = Building value ÷ 27.5

Answer 37

Tax savings Tax savings = Taxable income deduction × Marginal tax rate