Real Estate Analysis – Investment Property Calculator blog
Info about Real Estate Analysis and Real Estate Investment Software

Depreciation (or sometimes called cost recovery) is the amount of the tax deductions that an investor can take each year from the depreciable asset, until this asset is fully written off. In Real Estate only the building part (not the land underneath it) can be counted for depreciation. The property can be depreciated over its useful life. The useful life is specified by the tax laws and usually is not the same as the expected actual physical life of the property. According to the current tax laws, residential properties are depreciated over 27.5 years in the USA and nonresidential (commercial) over 39 years. Closing costs and capital improvements are both depreciable in a similar way.

P/E (Price to Earnings) ratio is often used when measuring other investment tools, such as stocks. The Real Estate P/E ratio counts with the initial investment and annual net operating income. It gives an investor a good comparison of possible use for his money in other investments, especially on the stock market.

Technorati Tags: house p/e ratio, p/e ratio in real estate, real estate dictionary

Debt coverage ratio is the real estate ratio between the annual net operating income (NOI) and annual debt service (ADS) of the particular property. ADS is the total of 12 monthly mortgage payments. If NOI and ADS are the same amounts, DCR equals 1.0. This however would not be enough for a mortgage lender, who always requires some margin of safety and therefore DCR must always be higher than 1.0 (usually at least 1.20).

Technorati Tags: DCR, Debt Coverage Ratio, Real Estate Analysis, real estate dictionary

Internal Rate of Return (annualized yield rate) is a rate which an investment will return over the estimated period of ownership. It is in fact the discount rate that produces NPV of zero and profitability index of 1.0. There are a few setbacks when using IRR, such as dual IRR in certain cases or problems with negative cash flows in the future.

There is no simple equation for calculating IRR, however when using some programming language for the calculation, the method of interval halving can be used. Fortunately for all of you, RealEstateAnalysisFREE software calculates IRR for you, in matter of seconds!

Technorati Tags: internal rate of return, Internal Rate of Return in real estate, IRR, Real Estate Analysis, real estate dictionary

Profitability index (profit index) is very similar to NPV. It also calculates with the present values of future cash flows and discount rate, therefore it takes in account the time value of money. Profitability index is a ratio which shows if the present value of the cash flows is worth the initial investment. If these values equal (NPV = 0) profitability index will be 1.0. The advantage of using this ratio when comparing different investments is the fact that it tells the proportion of money returned to money invested, rather than the amount as NPV does. This way you can easily compare two investments opportunities which require different initial investments.

Technorati Tags: PI, profit index, profitability index, Real Estate Analysis, real estate dictionary

Net Present Value is probably the best measure of any investment thanks to its complexity. It takes into account all the future cash flows including the selling price, and it converts all these amounts to their present values using discount rate required by the investor. In contrast with most of the measurements, NPV counts fully with the time value of money.

NPV is calculated as a total of all future cash flows discounted to their present values using appropriate discount rate, minus initial investment (CF0). Discount rate (i) is a rate of return that could investor earn on alternative investment with a similar risk (i.e. on financial markets).

Zero NPV indicates that the investor is earning exactly the discount rate. Negative NPV means that an alternative investment with the same rate of return as the discount rate would be a better investment. On the other hand positive NPV tells the investor how much he could have paid more to still achieve the requested yield (discount rate) and negative NPV tells how much less he should pay to achieve the same.

I hope you enjoyed the short article about NPV. By the way, this is where lot of Real Estate Investment Software products differentiate, lot of the low quality tools do not even mention NPV, which definitely a big mistake and can make the investor doing foolish decision on non sophisticated return calculations. Beware of these tools and make sure that they offer NPV calculation. Or simply use the free Real Estate Analysis FREE on this website!

Technorati Tags: net present value, net present value for investment property, net present value in real estate, NPV, NPV in real estate, property analysis, Real Estate Analysis

After a week, there is another term in our Real Estate Dictionary for all investors hungry for definitions! This one will definitely help you with your property analysis, especially if you are looking for a financing.

Break-even ratio is another benchmark used by mortgage lenders. It estimates how vulnerable is a certain property to defaulting on its mortgage if part of the rental income is declined. Most of the lenders are looking for BER of 85% or less.

Technorati Tags: BER, Break-Even Ratio, property analysis, Real Estate Analysis, real estate dictionary

Operating expense ratio is the ratio of operating expenses to the gross operating income (GOI). It is advisable to count this ratio not only on the total of operating expenses, but separately on each one. This way any nonstandard expense can be identified, when comparing similar investment properties.

Technorati Tags: OER, Operating Expense Ratio, property analysis, Real Estate Analysis, real estate dictionary

Cash flow is probably the first term which real estate investors learn in property analysis. It simply represents all the inflows and outflows of cash for a certain property. Next to appreciation and tax shelter, it is one of the most important Real Estate investment returns. Cash flow is not affected by a depreciation deduction since it is not a cash item. However it is affected not only by the interest portion but by the entire amount of the mortgage payment. All the capital additions or improvements paid during the year have to be subtracted from the total incomes and therefore lower the Cash Flow.

It is possible to calculate cash flow before taxes (CFBT), which is used more often or cash flow after taxes (CFAT) which is CFBT minus any tax liability arising from the operation of the property.

Cash flow simply represents all the inflows and outflows of cash for a certain property. Next to appreciation and tax shelter, it is one of the most important Real Estate investment returns. Cash flow is not affected by a depreciation deduction since it is not a cash item. However it is affected not only by the interest portion but by the entire amount of the mortgage payment. All the capital additions or improvements paid during the year have to be subtracted from the total incomes and therefore lower the Cash Flow.It is possible to calculate cash flow before taxes (CFBT), which is used more often or cash flow after taxes (CFAT) which is CFBT minus any tax liability arising from the operation of the property.

Technorati Tags: cash flow, cash flow after taxes, cash flow before taxes, CFAT, CFBT, Real Estate Analysis, real estate dictionary

After a while, here is another definition of an Real Estate Analysis term – the taxable income.

Taxable income is the amount on which the taxes have to be paid. It is different from the net operating income, because there are certain tax laws that dictate which expenses are deductible. It is not possible to deduct the whole mortgage payment, but it is generally possible to deduct the entire interest portion. Depreciation is also deductable. It is not possible to use the whole purchase price for tax deductions, because only the portion representing the buildings (not the land) can be deducted according to the tax code.

Technorati Tags: property analysis, Real Estate Analysis, taxable income