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Real Estate Investing – Key Terms and Formulas, Part 2

In this article, Real Estate Investing – Key Terms and Formulas, Part 2, we continue our list with ten more key real estate investing terms and formulas. Be sure to read Part 1 if you want to have the entire list.

1. Cash on Cash (CoC) A percentage measure of the ratio between the property's annual cash flow (usually the first year and before taxes) and the amount of the initial capital investment. The formula is Cash on Cash = Annual Cash Flow / Cash Invested.

2. Time Value of Money This is the underlying assumption that money, over time, will change value. That the money you have in hand today is preferable to having that same amount of money one or more years from now. Investments in real estate must be studied from a time value of money standpoint because the timing of receipts from the investment might be more important than the amount received.

3. Present Value (PV) This shows what a cash flow or series of cash flows available in the future is worth (in purchasing power) today. It's calculated by "discounting" future cash flows back in time using a given rate of return (i.e., discount rate). It is particularly helpful with real estate investment property when you're trying to figure out what the cash flows produced in the future are worth in today's dollars.

4. Future Value (FV) This shows what a cash flow or series of cash flows will be worth at a specified time in the future. It's calculated by "compounding" the original principal sum forward at a given compound rate.

5. Net Present Value (NPV) This discounts all future cash flows by a desired rate of return to arrive at a present value (PV) of those cash flows and then deducts it from the investor’s initial equity (capital invested today). The resulting dollar amount is either negative (return not met), zero (return perfectly met), or positive (return met with room to spare).

6. Internal Rate of Return (IRR) This model creates a single discount rate whereby all future cash flows can be discounted until they equal the investor’s initial investment.

7. Operating Expense Ratio This provides the ratio of the property's total operating expenses to its gross operating income (GOI). The formula is Operating Expense Ratio = Operating Expenses / Gross Operating Income.

8. Debt Coverage Ratio (DCR) This is a ratio for the number of times that net operating income (NOI) exceeds debt service. The resulting number is either less then 1.0 (less than enough to cover the debt), exactly 1.0 (just enough to cover the debt), or greater then 1.0 (more than enough to cover the debt). Lenders typically require a DCR of 1.2. The formula is Debt Coverage Ratio = Annual Net Operating Income / Annual Debt Service.

9. Break-Even Ratio (BER) This measures the proportion of money going out to money coming in and tells the investor what part of gross operating income (GOI) we be consumed by all estimated expenses. The result always must be less than 100% for a project to be viable (the lower the better; lenders typically require a BER of 85% or less). The formula is (Operating Expense + Debt Service) / Gross Operating Income.

10. Loan to Value (LTV) This measures what percent of the property's appraised value or selling price (whichever is less) attributable to financing. Real estate investors use it to measure leverage (higher LTV means greater leverage), whereas lenders regard a higher LTV as a greater financial risk. The formula is Loan to Value = Loan Amount / Lesser of Appraised Value or Selling Price.

ProAPOD® Real Estate Investment Software makes calculations for all these financial measures and returns and posts them in each appropriate report automatically as you enter the property data. Recalculations are made instantly when you change your data.

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