Real Estate Finance

Question 1

What is the formula for taxable income?

Answer 1

Taxable income = NOI - Mortgage Interest - Depreciation - Amortization

Question 2

What IRS form indicates the amount of interest paid for the year?

Answer 2

IRS Form 1098

Question 3

What are the three measurements of profit margin, and what does each metric measure?

Answer 3

• Gross Profit Margin measures how efficiently a company is producing their products compared to their competitors
• Operating Profit Margin measures how efficeintly a company’s operations are
• Net Profit Margin measures a company’s overall efficiency

Question 4

What is the difference between COGS and OPEX (in real estate)?

Answer 4

COGS are expenses incurred by a business to produce the product or service that the business provides. For example, a flipping business could incure COGS from renovation labor costs and rehab materials.

Operating expenses are expenses associated with the basic functions of operations of the property, such as insurance, repairs, and maintenance, and taxes

Question 5

What are the five examples of rent loss?

Answer 5

Vacancy, concessions, loss to lease, bad debt, model units

Question 6

What is the formula for Gross Operating Income (GOI) in real estate

Answer 6

GOI = Gross Potential Rent - Rent Loss + Other Income

Other income could be things like parking space income, washer/dryer income, etc

Question 7

What is the formula for gross potential rent?

Answer 7

Gross potential rent = number of units x market rent x 12

Question 8

What is the formula for Net Operating Income (real estate)

Answer 8

NOI = gross operating income - operating expenses

Question 9

What is the formula for Cash Flow (real estate)

Answer 9

Cash flow = NOI - Debt Service - Capital Expenditures

Debt service is typically the regular P&I payment to the lender (usually a mortgage pmt)

Question 10

What is the formula for Total (simple) Interest

Answer 10

Total Interest = Principal x Interest rate x Number of years

Interest = $10k x 0.05 x 2.5 = $1,250

Question 11

What is the Rule of 72

Answer 11

Number of years to double = 72 / Rate of return

Question 12

What is the Future value Formula

Answer 12

FV = PV x (1 + i) ^n

Question 13

The NOI equation omits which two major expense categories (in addition to taxes)?

Answer 13

Captial expenses and debt service

Question 14

What is the difference between simple interest and compounding interest?

Answer 14

With simple interest, profits are removed from the investment. Compound interest means you are reinvesting your interest (profits) back into your investment.

Question 15

What is the key to making good decisions using expected value?

Answer 15

Having accurate probabilities for each outcome

Question 16

What input does net present value consider that discounted cash flow does not?

Answer 16

NPV factors the initial capital investment into the calculation; DCF analysis does not

Question 17

What is a simple way to describe what IRR measures

Answer 17

IRR is a the time-weighted compound annual growth rate of an investment

Question 18

What is the relationship between IRR and NPV

Answer 18

IRR is the discount rate that makes NPV = 0

Question 19

What is the formula for taxable income?

Answer 19

taxable income = NOI - mortgage interest - depreciation - amortization

Question 20

What are the two most common measurements of profit for real estate investors?

Answer 20

NOI and Cash Flow

Question 21

What is the formula for NOI?

Answer 21

Gross Operating Income - Operating Expenses

Question 22

What is ROI and what is the formula?

Answer 22

ROI is the same as interest rate.

ROI = (Ending value - Starting value) / Starting Value

ROI does not take time into consideration. For example, if you have an investment that earns 20% ROI after one year, and you have a second investment that also earns 20% ROI after three years, the first investment will be more valuable

Question 23

What is Annualized ROI and the formula for it?

Answer 23

Annualized ROI = ROI / Years Held

Annualizing ROI means that regardless of the actual length of the investment, we calculate what the average ROI would be for each year of the investment

Question 24

What is the major limitation of the ROI equation?

Answer 24

It doesn’t factor in TVM

Question 25

What is the equity multiplier (EM) formula and what does it mean?

Answer 25

EM = Ending Value / Starting Value

EM gives us an indication of how many times our investment has increased, inclusive of all cash flow and profits generated throughout the hold period.

An EM of 1 indicates that you didn’t make or lose any money - your ending value is the same same as your starting value

Question 26

What is the equation for Cap Rate?

Answer 26

Cap rate = NOI / Value

Question 27

What does it mean when a market is ‘efficient’?

Answer 27

Investors within that market tend to be particularly knowledgeable and sophisticated, and there is enough demand for those properties that they will sell for very close to what they are worth. In other words, in efficient markets, it’s often difficult to get a smoking-hot deal, simply because you are competing with a lot of other smart investors for the same assets.

Question 28

Why is cap rate so useful for comparing properties?

Answer 28

Cap rate is calculated using NOI and the property value as inputs. Because NOI doesn’t consider CapEx or debt service in the equation, it takes the preferences and decisions of the individual investor out of the equation. In other words, cap rate gives us the annual ROI of an all-cash deal, which is an unbiased way to compare two properties against one another, regardless of how the deal is being financed and the future intent of the purchaser for the property

Question 29

What is the formula for Cash on Cash?

Answer 29

COC = Annual Cash Flow / Total Cash Invested

Question 30

What is the preferred return (‘pref’) as it pertains to a waterfall distribution framework?

Answer 30

The minimum rate of return before the project manager receives carried (aka promoted) interest

Question 31

What is the carried interest as it pertains to a waterfall distribution framework?

Answer 31

A share of the proect’s profits given to manager as a performance incentive (i.e. for making the investors money)

• can be tiered with hurdles