Real estate investors use a great number of formulas and ratios to determine the feasibility of investing in a particular property or project. Below is a brief and simplified explanation of the most commonly used formulas used to analyze real estate investments:

**Debt to Income Ratio**

__What it Measures__

The percentage of monthly income that goes towards making debt payments, including mortgages, student loans, car loans, credit card payments and child support.

__Formula
__Debt to Income Ratio = Total Debt Payments / Total Income

__Detail
__This is one of the most widely ratios used by loan underwriters before approving/rejecting a loan application. Typically, lenders want to see no more than 36% of a borrower’s income going towards debt payments.

**Capitalization Rate (aka Cap Rate)**

__What it Measures
__The rate of return on a real estate investment based on a property’s income in relation to its price. Cap rate calculations assume that a property is paid for all-cash and does not consider debt financing.

__Formula
__Cap Rate = Net Income / Price

__Detail
__The cap rate for a property must be compared to that of similar properties or investment assets to determine if a property is worth purchasing or not. The higher the cap rate, the more attractive the investment. Cap rates typically range from 3-12%.

**Loan to Value (LTV)**

__What it Measures
__The size of a loan compared to the value of the property securing the loan. This formula is mostly used by loan underwriters to assess the risk of a loan versus its collateral.

__Formula
__LTV = Mortgage Amount / Appraised Value of the Property

__Detail
__Typically, a maximum LTV of 80% is required before a lender will approve a loan for a given property. This means that for a house worth $200K, the maximum loan amount approved by the lender will be $160K. If a buyer wishes to purchase a more expensive house, the borrower will either need to come up with a greater down payment, or they will need to buy Private Mortgage Insurance (PMI) amount to protect the lender against a loan default.

**Absorption Rate for Home Sales**

__What it Measures
__The number of months it would take to sell all the currently listed homes on the market. It is used to predict sales activity.

__Formula
__Absorption Rate = Number of Active Homes x Rate of Home Sales

*To calculate the Rate of Home Sales (Time Frame / Number of Home Sales)

__Detail
__An absorption rate of 20% usually means homes are selling quickly (sellers market).

**Vacancy Rate**

__What it Measures
__The percentage of all vacant units in a property. It is opposite the occupancy rate. Both rates should add up to 100%.

__Formula
__Vacancy Rate = Number of Vacant Units / Total Number of Units

__Detail
__In an ideal world, vacancy rates should be zero. However, investors and lenders typically assume a 10% vacancy rate.

**Return on Investment (ROI)**

__What it Measures
__The return on an investment.

__Formula
__ROI = (Total Revenue – Investment Cost / Investment Cost) x 100

__Detail
__There is no standard ROI rate. The ROI for an investment is compared to that of similar investments in the same asset class. In theory, any positive ROI (profit) is good.

**Cash on Cash Return**

__What it Measures
__The cash flow performance of income-producing assets, based on the amount of cash invested.

__Formula
__Cash-on-Cash Return = Annual Before Tax Cash Flow / Total Cash Invested

__Detail
__Similar to cap rates, cash-on-cash rates must be compared to that of similar properties or investment assets to determine if a property is worth purchasing or not. The higher the cash-on-cash rate, the more attractive the investment. Cash-on-cash rates typically range from 6-12%.

**Gross Rent Multiplier (GRM)**

__What it Measures
__The financial performance of income -producing/rental properties. Basically, GRM tells you how long it takes for a property to “pay for itself”.

__Formula
__GRM = Price / Potential Gross Income

__Detail
__GRM’s must be compared to that of similar properties or investment assets to determine if a property is worth purchasing or not. The lower the GRM (i.e. the faster the property pays for itself), the more attractive the investment.

For instance, a property priced $500,000 which brings in $5,000 per month in rents ($60,000 per year):

GRM = 500,000 / 60,000

GRM = 8.33 Yrs.

Therefore, it will take 8.33 years for this property to pay for itself. Realistically, however, rents will probably be hiked over the years, improving the GRM.

**Debt Service Coverage Ratio (DSCR)**

__What it Measures
__How large a commercial loan can be supported by the cash flow generated from a property.

__Formula
__DSCR = Annual Net Operating Income / Annual Debt Service

__Detail
__Each lender has their own DSCR parameters. However, in almost all cases a DSCR of greater than 1 is required (i.e. your income is higher than your debt service). In general, a DSCR below 1 shows that an investor does not have enough cash on hand to comfortably cover loan payments. Typically, lenders are looking for ratios of 1.25 or higher.