There are a tonne of real estate formulas that all commercial property investors should know, but if you’re just beginning to grow your portfolio, here are the 3 most important real estate formulas you should concentrate on first:
Your Price-to-Rent ratio is also sometimes called a Buy-to-Let Rental Yield. This formula shows you how much rent you’ll receive against the price at which you purchased your property, and is an essential formula when comparing potential real estate investments. This is one of the simplest ways to work out whether a property is a good investment or not.
Price to rent ratio = Purchase Price of Property ÷ Annual Rental Revenue.
However, remember to include hidden costs. For example, purchasing a property that needs substantial roof repairs before tenants move in might seem like it returns a good price-to-rent ratio until you factor in the cost of the roof repair.
Equity Build-Up Rate
You should already know that real estate rarely returns on investment right away. There are many properties you can purchase that have the potential to build equity over time, but it’s important to know how long you’ll have to wait to build up that value. That’s where your ‘Equity Build-Up Rate’ comes in.
To figure out the equity build-up rate of a property. You need to divide the mortgage principal paid in year 1 by the cash you invested in the first year. (As an expression, this can be written as Equity Build-Up Rate = Mortgage Principal Paid ÷ Initial Cash Invested.)
Equity build-up is the perfect real estate formula to use if you’re looking at purchasing property in an up-and-coming area that’s tipped for a boom.
Price Per Square Foot
Price per square foot is one of the simplest ways to work out how much property you get for your money. This formula is a helpful way to compare different sized properties, and helps you to make sure you’re not paying over the odds for a property in a particular area.
Price per square foot = Market Value of Property ÷ Property Square Footage
Remember, price per square foot can be deceptively simple, so make sure you look at other factors. If the property is structurally flawed or needs extensive renovations doing to it before being put to work in your portfolio, then your price per square foot may look like a better investment than it is.
Once you’ve mastered these three crucial real estate formulas, you can begin expanding your arsenal. Why not take a look at your overall return on investment, cap rate, and potential returns?