SMART Real Estate Investing System

Introduction to SMART Real Estate Investing

SMART Glossary




CAPITALIZATION RATE (Cap Rate)

  1. Formula: Net Operating Income / Purchase Price
  2. Similar to Return on Investment (ROI)
  3. Example:
    1. Monthly Rent: $4,400
    2. Monthly Expenses: $1,030
    3. Net Operating Income: $3,370
    4. Asking $639,000
    5. Cap Rate: 6.3%
  4. The higher the cap rate, the better for the buyer
  5. Tip: Compare cap rates in the area you are investigating

CASH FLOW

  1. Net Operating Income (NOI) - Vacancy - Debt Service
  2. Example:
    1. NOI: $3,370
    2. Vacancy (e.g., 5% of income): $220
    3. Mortgage: $2,288
    4. Cash Flow: $862
  3. Tip: Set your goal for minimum monthly cash flow

CASH ON CASH RETURN

  1. Formula: Annual Net Cash Flow / Purchase Costs
  2. Expressed as a percentage
  3. Example:
    1. Asking: $639,000
    2. Down Payment: (25%): $159,750
    3. Estimated Closing Costs (1.5%): $9,585
    4. Estimated Initial Rehab (1.0%): $6,390
    5. Total Purchase Costs: $175,725
    6. Annual Net Cash Flow: $10,350
    7. Cash-on-Cash Return: 5.9%
  4. Tip: Set your goal for minimum Cash-On-Cash Return %

CLOSING COSTS

  1. Costs associated with the escrow process
  2. Typically includes escrow fees, transfer taxes, ...   and commission (on the listing side)
  3. Generally runs about 1.0-2.0% of the Purchase Price in Southern California

DEBT SERVICE

  1. Mortgage payments, including principle and interest
  2. Debt Service is used to determine Cash Flow (see above)

DEBT SERVICE RATIO

  1. Ratio of Net Operating Income (NOI) to Debt Service
  2. Example:
    1. NOI (monthly): $3,370
    2. Mortgage (monthly): $2,288
    3. Debt Service Ratio: 1.9
  3. Used by lenders to qualify borrowers

EQUITY VALUE

  1. Property value less loan balance

ESTOPPEL

  1. Tenant-provided written verification of lease amounts and terms

GROSS RENT MULTIPLIER (GRM)

  1. Formula: Purchase Price / Gross Scheduled Income (GSI)
  2. Similar to a stock investor "Price/Earnings Ratio"
  3. Example:
    1. Asking Price: $639,000
    2. GSI (annual): $52,800
    3. GRM: 12.1
  4. The lower the GRM, the better for the buyer
  5. GRMs under 15 are often positive cash flow, depending on expenses
  6. Key Tip for Investors: Compare Gross Rent Multipliers to similar properties in the area in which you are looking!

GROSS SCHEDULED INCOME (GSI)

  1. Formula: Sum of Monthly Income per unit for all units
  2. aka "Scheduled Gross Income (SGI)"
  3. Can include Auxiliary Income (e.g., washing machines, garage rental, vending machines)
  4. Example:
    1. Unit 1: $1,900/month
    2. Unit 2: $1,400/month
    3. Unit 3: $1,100/month
    4. Washing Machines: $0/month
    5. GSI: $4,400/month

IMPROVEMENT COSTS

  1. Costs associated with making the property attractive, safe, habitable and rentable
  2. Typically includes construction upgrades, landscaping, etc.

LONG TERM RETURN ON INVESTMENT

  1. Ratio of Total Costs to Total Net Equity Gain over time (e.g., 5 or 10 years)
  2. Example:
    1. Initial Investment:
      1. Down Payment (25%): $159,750
      2. Closing Costs (1.5%): $9,585
      3. Up-Front Improvements (1%): $6,390
      4. Total Initial Investment: $175,725
    2. 10 Year Gain:
      1. Cash Flow (3%): $118,762
      2. Appreciation (3%): $219,763
      3. Mortgage Payback: $101,678
      4. Total 10 Year Gain: $440,202
    3. 10 Year ROI: $175,725  / $440,202 = 251%

NET OPERATING INCOME (NOI)

  1. Formula: Gross Scheduled Income (GSI) - Operating Expenses
  1. Example:
    1. GSI (monthly): $4,400
    2. Operating Expenses (monthly): $1,030
    3. Net Operating Income (monthly): $3,370
  2. Note: NOI does not include Debt Service (mortgage payments) or Vacancy

OPERATING EXPENSES

  1. Expenses, other than Vacancy and Debt Service
  2. Generally includes:
    1. Property tax
    2. Insurance
    3. HOA fees
    4. Property management fees
    5. Maintenance
  3. Often grossly estimated at 30-35% of GSI
  4. Tip: Banks often use 35% of GSI to calculate operating expenses for loan qualification purposes
(Click here for a list of some additional expenses) Cable TV
Electricity
Pest Control
Gardener
Security
Gas
Supplies
Trash
Licenses
Water/Sewer
Maintenance
Appliance Repair/Replacement
Carpet Replacement


TOTAL INVESTMENT

  1. Cash outlay to obtain property
  2. Includes:
    1. Down Payment
    2. Closing Costs
    3. Initial Improvement Costs

VACANCY

  1. The average time between tenants, expressed as a percentage of income
  2. Example: a 5% vacancy rate equates to about 2.5 weeks of lost rent


RESIDENTIAL INCOME PROPERTY ANALYSIS
COMPLETE EXAMPLE

BASIC
Asking Price $639,000
# Units 3
Total Income $4,400 Monthly
Gross Rent Multiplier (GRM)  12.1
EXPENSES
Property Tax $666 1.25%
Insurance $64 0.12%
HOA $0
Property Management $0
Maintenance/Unit $300 $100
Other $0
Total Expenses $1,030
% Total Income 23%
Net Operating Income (NOI) $3,370 Monthly
Cap Rate 6.3%
Vacancy $220 5%
LOAN
Down $159,750 25%
Loan Amount $479,250
Interest Rate 4.000%
Years 30
Type Fixed
Mortgage $2,288 Monthly
CASH FLOW
Net Cash Flow $862 Monthly
INITIAL INVESTMENT
Estimated Closing Costs $9,585 1.5%
Estimated Initial Repairs $6,390 1.0%
Total Initial Investment $175,725
Cash-On-Cash ROI 5.9%
10 YEAR HORIZON
Total Cash Flow $118,762 3.0%
Total Appreciation $219,763 3.0%
Total Mortgage Payback $101,678
Total 10 Year Gain $440,202
10 Year ROI 251%