# Allison Bethell

### Expertise:

- Real Estate Investing

### Experience:

December 6, 2018

### Balloon Mortgage Calculator

A balloon mortgage is a loan that offers low initial monthly payments, and then a large portion of the principal is repaid in a lump sum at the end of the term. A balloon mortgage calculator helps you calculate your monthly mortgage payment, your balloon payment and the total amount of interest paid during the loan.
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How the Balloon Payment Calculator Works
The balloon payment calculator works by taking the things you input like home price and uses an amortization schedule and a balloon payment formula to calculate your monthly payment on your balloon mortgage. It will also tell you how much your balloon payment will be at the end of the loan. After using the free balloon mortgage calculator, you should be able to determine if a balloon mortgage makes sense for you.
A balloon mortgage is a loan that is amortized over 30 years but typically has a loan term between five and seven years. At the end of the loan term, a balloon payment is due, which is a lump sum made up of a large portion of the principal balance. Our balloon loan calculator will do the math for you and estimate how much your balloon payment will be.
The balloon mortgage monthly payment is calculated by using a 30-year amortization table and your interest rate. Your final balloon payment is determined by the remaining principal owed after all of your monthly payments have been made. This balloon payment is a lump sum due at the end of the loan term.
Here is some information to help you assess your results from the balloon payment calculator:
Typical balloon mortgage interest rate: 4.5 to 5.5%
Typical balloon loan term: 5 to 7 years
Balloon payment: The lump sum of what’s owed on the loan at the end of the term
Balloon Mortgage Calculator Inputs
When using our free balloon mortgage calculator, you will be prompted to input your home price, down payment, mortgage amount, term and interest rate. These are the inputs the balloon mortgage payment calculator needs in order to calculate things like your monthly payment. The balloon mortgage calculator uses a balloon payment formula for its calculations, based on an amortization schedule with a balloon.
The details for each input into the mortgage calculator with balloon payment are:
Price of Property
The first input that the balloon mortgage calculator asks for is your home price. This is the purchase price of your property, which is how much you paid for the property. Keep in mind that it’s not what the property is worth today. If you’re considering purchasing a property, this number will appear on your agreement of sale. If you already own the property, the purchase price will be on your HUD-1 settlement statement, which is part of your closing documents.
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Down Payment on Property
The down payment is how much of your own money you put towards the property. It’s the portion that you didn’t finance. For example, if you purchased a property for $100,000 and financed 80 percent of it, your down payment would be 20 percent or $20,000. You can find the amount of your down payment on your agreement of sale and on your HUD-1 statement.
A typical down payment required for a balloon mortgage is 10 percent. If you haven’t purchased the property yet, your balloon mortgage lender will be able to tell you what your minimum down payment is.
Mortgage Amount of Investment Property
The next input needed on the balloon loan calculator is the mortgage amount. This is the amount of the property that you’re financing. Typically, you will finance 90 percent or more with a balloon mortgage. For example, if the purchase price of the property is $100,000 and you put down $10,000 as your down payment, your mortgage amount will be $90,000.
You can find your mortgage amount on your mortgage statement, by contacting your mortgage lender or on your online mortgage account. If you saved your closing documents, your mortgage amount will also be on the mortgage documents that you signed.
Balloon Mortgage Loan Term
A balloon mortgage loan term is the length of the balloon mortgage. Typically, balloon mortgage terms are five to seven years. However, some lenders will fund balloon mortgages with terms up to 15 years. You can find your loan term on your mortgage documents from settlement and on your mortgage statement. If you’re shopping around for a balloon mortgage, the lenders will tell you what terms they offer.
Interest Rate of Balloon Mortgage
Typically, a balloon mortgage interest rate is lower than that of a conforming loan. Balloon mortgage rates are generally 4.5 to 5.5 percent. You can find your interest rate on your mortgage documents from closing, and you can also request it from your lender. If you don’t remember your exact rate, don’t worry, our calculator uses an average rate of 5%.
Balloon Payment Calculator Outputs
After you have input all of the necessary inputs into the balloon mortgage calculator, including home price and interest rate, the calculator will calculate the numbers for you and give you your balloon mortgage monthly payment, your balloon payment and the total interest paid during your balloon mortgage.
The balloon payment calculator uses your inputs and a built-in amortization table based over 30 years to do these calculations. Using our free balloon mortgage calculator will save you time, and you won’t have to do any calculations by hand or search online for an amortization table.
Balloon payment calculator outputs include:
Balloon Mortgage Monthly Payment
The first output that our balloon loan calculator calculates is your monthly mortgage payment. This is the amount of interest and principal that you pay monthly during the term of the loan. This calculation is amortized over 30 years and uses your interest rate to do the calculation. Knowing your monthly mortgage payment will help you decide if a balloon mortgage is a viable option. If you have an interest-only balloon loan, you can choose that input instead of a principal and interest loan.
Balloon Payment
Next, our balloon mortgage payment calculator calculates your balloon payment. This is the lump sum due at the end of the loan term. It’s when the majority of your principal will be due because during the beginning of the loan term you were paying mostly interest and just a small amount of principal.
The balloon payment is the most important calculation because it dictates whether or not you can afford to get a balloon mortgage. You need to be able to sell the property and pay off this balloon payment, or you need to refinance the mortgage or pay it off with a lump sum. By using our free balloon mortgage calculator, you will find out how much the balloon payment will be and then be able to plan an exit strategy. Some people may also plan on refinancing, and the monthly payment would be a larger indicator of affordability.
Total Interest Paid for Balloon Mortgage
The last output that the balloon mortgage calculator gives you is the total interest paid during your balloon mortgage. This calculation is based on your interest rate, amortization during the loan and the loan term. You will be able to see how much your total interest is and compare it to what interest you would pay by using a different type of loan.
When to Use a Balloon Mortgage
A balloon mortgage can be used by real estate investors and owner-occupants who know they will be selling or refinancing within two to three years. Investors and owner-occupants also use a balloon mortgage when they want to purchase a property but wouldn’t be able to afford it with a conforming loan. The balloon mortgage typically offers low initial monthly mortgage payments because the loan term is typically five to seven years, but the loan is amortized over 30 years. This makes it a more affordable option during the beginning of the loan.
However, a lump sum payment is due at the end of the loan term, so investors should only choose a balloon mortgage if they know they will be able to afford this balloon payment. Some risks involved with using a balloon mortgage include changing property values, interest rate changes and personal income changes. Typically, investors, who plan to sell a property, know they will inherit a lump sum or who will receive a large bonus or salary increase will opt for a balloon mortgage.
A balloon mortgage is a good option to use when:
An investor with a clear exit strategy in mind to repay the balloon payment, such as selling the property, paying it off or refinancing the loan
A commercial real estate investor wants initial low payments so he or she can increase cash flow and refinance the property before the balloon payment is due
A buy-and-hold investor who wants to take advantage of a lower interest rate and a lower monthly payment and who plans on selling or refinancing the property before the balloon is due
An owner-occupant who wants to purchase a property he or she wouldn’t otherwise qualify for and knows he or she will have the funds to cover the balloon payment
An investor who wants to rehab a rental property in an up-and-coming area and sell it for a profit before the balloon payment is due
Alternatives to a Balloon Mortgage
A balloon mortgage can be a great option for an investor who wants to take advantage of initially low monthly mortgage payments and is prepared for a lump sum due at the end of the loan term. However, balloon mortgages are specialty loan products and aren’t widely offered. If you can’t find a balloon mortgage lender or realize that a balloon mortgage isn’t right for you, there are some alternatives.
Alternatives to a balloon mortgage include:
Adjustable rate mortgage (ARM): This is a type of mortgage where the interest rate is initially fixed for a period of time; after that period of time is over, the interest rate resets; ARMs are usually 5/1 or 7/1 meaning they’re fixed for 5 or 7 years, and then can adjust once a year afterward for the duration of the loan; typically, ARMS are used by investors and owner occupants to payer lower interest during the initial period of the loan
Investment property loan: This type of loan is specifically for investors and can be found through banks, credit unions and online lenders; these loans typically have rates from 5 to 12 percent and terms of 3 to 30 years; investors typically use these loans to purchase buy-and-hold properties
Hard money loan: This is a short-term loan found through nationwide online lenders or private local lenders; rates are typically 7 to 13 percent and terms are six months to two years; investors use these loans to fix and flip properties or rehab, refinance and rent out a property
Jumbo loan: This is a specialty type of loan used for properties that don’t qualify for a conforming loan due to their high price range; typically, investors use a jumbo loan to purchase a luxury property, a 1-4 unit building or a property in a high-cost area; owner-occupants use a jumbo loan for a primary residence in a high-cost area or to purchase a luxury home.
The Bottom Line
A balloon payment calculator is a helpful tool used to assist an investor in deciding if a balloon mortgage is right for them. After putting inputs into the balloon mortgage payment calculator like your home price, down payment and mortgage amount, the balloon mortgage payment calculator does the work for you. The balloon payment calculator calculates your monthly mortgage payment, amount of your balloon payment and the total amount of interest paid during the loan.
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December 3, 2018

### Rental Property Depreciation: Rules, Schedule & Recapture

Rental property depreciation is a process that real estate investors use to deduct the costs associated with purchasing and improving an investment property. Depreciation of rental property happens over the course of the property’s useful life as determined by the IRS’ depreciation method. This is important for investors because rental property depreciation helps maximize tax savings.
How Residential Rental Property Depreciation Works
Residential rental property depreciation is a capital expense, which means it helps recover the costs you spend to acquire and improve your rental property. Depreciation expense is typically the largest tax deduction available to real estate investors and can help investors improve their cash flow by reducing their tax liabilities. This means every year you can reduce your taxable income without negatively impacting your cash flow.
The standard method of depreciation in the United States is called the modified accelerated cost recovery system (MACRS). Under this system, the capitalized cost basis of property is recovered over a specified life by annual deductions for depreciation. There are two types of MACRS: general depreciation system (GDS) and alternative depreciation system (ADS). Throughout the article, we use GDS because it’s the most common system, and ADS is less common.
Rental property depreciation is calculated over 27.5 years for residential property and 39 years for commercial property. These are the useful lives that the IRS deems for both types of properties. Keep in mind, real estate depreciation begins when the property is placed in service, meaning when you rent it out, not when you purchase it. Depreciation ends when you sell the property or take it out of service, such as if you decide to use it as your primary residence.
Depreciation of rental property covers major repairs that are capitalized, but you can’t use it to offset the cost of rental property normal wear and tear. It only covers purchases and improvements, and there’s often a fine line between what is considered an improvement and what is considered a repair. It’s best to consult with your tax advisor about whether something is an improvement or a repair.
For example, if you repair a few shingles on your roof, that’s considered a repair and is not depreciated. So, instead of depreciating the cost of the repairs, you can expense the full cost of the repair. In contrast, if you need to replace the entire roof, you would depreciate it over the useful life of the roof, which is 27.5 years, the same as the property to which its attached, determined by the IRS’ depreciation schedule because replacing the roof is not a repair but is considered an improvement.
When calculating rental property depreciation, the useful life of common assets are:
Appliances, carpeting & furniture: 5 years
Office furniture & equipment: 7 years
Fences & roads: 15 years
Residential rental buildings, structures, furnaces & water pipes: 27.5 years
Commercial buildings: 39 years
What Properties Are Depreciable?
The IRS determines what types of properties you can claim depreciation on. For instance, land, landscaping and a primary residence are not depreciable. In order for real estate depreciation to be applicable, you can’t place a property in service and sell it the same year you depreciate it. This means that you can’t rent out a property in January, sell it in April and claim depreciation on it that same year.
Properties that fall into at least one of the following categories are typically depreciable:
A rental property placed in service after 1986, which means it was used as a rental property after 1986 and is specific to the type of depreciation method you’re using; as we previously mentioned we use the GDS method
An income-producing property that is expected to last more than one year, which is generally true of all rental properties
Residential real estate used to produce income
Owner-occupied commercial real estate like a building where you operate your business
Income-producing commercial real estate like an office building or shopping center
Multifamily properties like buildings with two or more separate units such as a duplex or triplex
Rental Property Depreciation Method
There are certain rental property depreciation rules that the IRS expects you to follow. They include using the MACRS that spreads costs and depreciation deductions over 27.5 years for residential properties and 39 years for commercial properties. Keep in mind that we are using the GDS of MACRS and not the ADS.
Now, let’s look at the formula for MACRS which is the cost basis of the asset multiplied by the depreciation rate. The cost basis is the same as the purchase price of the property. You can find which depreciation rate you should use in one of the three tables the IRS provides in Publication 946.
MACRS Formula Using GDS = Cost basis of the asset x Depreciation rate
Let’s look at an example of how to use the MACRS formula.
The IRS establishes that any residential rental property placed in service after 1986 is depreciated using the useful life of the property. Although the MACRS formula is simple, we suggest consulting with a tax professional to calculate MACRS because the depreciation rate used varies depending on the type of asset being depreciated.
Although MACRS is used on the real estate itself, typically, the straight line depreciation method is used on other improvements. This means that these items can be depreciated and deducted over time such as a new roof or new windows, doors, plumbing systems, etc.
For more information on rental property tax deduction rules, check out our in-depth guide on rental property tax deductions and benefits.
Rental Property Depreciation Schedule
A rental property depreciation schedule helps you value your assets, calculate your depreciation expenses, and calculate your capital expenses. A rental property depreciation schedule shows what kind of depreciation you can take and deduct each year. It shows the breakdown of the land value and the building value because you can only depreciate the building value. It’s based on the useful lifespan allowed by the IRS for the property type.
A rental property depreciation schedule generally includes the:
Property type you’re depreciating: Such as buildings and structures, office equipment, machinery, furniture or vehicles on a property
Type of depreciation used: For example, if you’re using the more common GDS method or the alternative method (ADS)
Cumulative depreciation to date: This is how much the asset has depreciated from the time it was put in service until the present date
Future depreciation forecast: This is a prediction of how much depreciation the asset will incur during a certain period of time in the future
Reporting Depreciation of Rental Property
Now that you know what rental property depreciation is and how it works, you need to know where to report it, especially if you’re doing your own taxes. Although we do recommend working with a tax professional, it may be helpful to know where to report depreciation of rental property on your tax documents.
Here are three steps to help with reporting residential rental property depreciation.
1. Use a Schedule E to Record Income and Expenses
Typically, you will receive a 1040 federal income tax return, and you will use the Schedule E to record all of your rental property income and expenses. Generally, your accountant will help you fill this out.
2. Figure Out Your Net Gain or Net Loss
After you fill out the Schedule E, you figure out if you had a net gain or a net loss and record how much it is on the 1040 form. One of the major expenses that should be listed on your Schedule E is your rental property depreciation. This is where you depreciate expenses that have a useful life of more than one year.
Typical expenses that you need to depreciate on a rental property include:
New roof
Replacing a bathroom
Replacing a kitchen
The formula that you should use to depreciate these expenses is:
Divide the total cost of the item by the useful life of the improvement
Then you write that expense as a fraction. For example, if you spend $15,000 on a driveway with a 15-year useful life, you divide $15,000 by 15 and get $1,000. This means you can write off $1,000 per year during the driveway’s useful life.
3. Depreciate the Purchase of the Property
You can do the same thing as in step 2 when you purchase the property, which is usually your largest real estate related expense. However, the useful life of a residential rental property building is 27.5 years, and the land can’t be depreciated, so you need to subtract the cost of the land from the total property cost.
Let’s look at a quick example:
You purchase a property for $300,000. The land is worth $125,000, and we already know the useful life of a residential building, according to the IRS is 27.5 years. Now, let’s figure out how much the building is worth by itself. We subtract the land from the total property cost and get $175,000.
$300,000 - $125,000 = $175,000
Now, we know the building is worth $175,000, and we want to depreciate it over 27.5 years, so we divide it by 27.5 and get $6,363.64.
$175,000 / 27.5 = $6,363.64
This is the amount you can take as a depreciation per year on the purchase of your investment property. This reduces your tax liability by $6,363.64 per year while keeping your cash flow the same. Basically, you’re adjusting your cost basis downward each year by the amount of depreciation taken.
Rental Property Depreciation Recapture
Rental property depreciation recapture is the gain that the real estate investor receives from selling the investment property, and it must be reported as income to the IRS. This can hurt an investor because it’s additional income that you have to pay taxes on based on your ordinary tax rate, which can be in addition to capital gains tax. Depreciation of rental property should be reported on IRS Form 4797.
When you take depreciation, you’re adjusting the property’s cost basis downward. So, when you sell the property, you have to pay taxes on it because you previously offset some of your ordinary income taxes by claiming depreciation. Depreciation recapture is assessed when the property’s sales price exceeds its adjusted cost basis. An adjusted cost basis just means the net cost of the asset after it’s been adjusted for depreciation. We’re going to explain this in more detail in six steps.
Keep in mind that capital gains tax on real estate is also due when you sell an investment property for more than you purchased it for. Part of the profit is taxed as a capital gain and may qualify for the 20 percent capital gains tax, and the other part of the profit is taxed at the ordinary tax rate, which is generally higher than the capital gains tax rate.
Part of the profit that is taxed at the ordinary tax rate because it was depreciated over time. This can get complicated, so we suggest consulting with a tax professional. The IRS uses rental property depreciation recapture as a way to collect taxes on profits from the sale of a rental property. This is because the taxpayer was able to previously write depreciation off against their taxable income during their ownership of the property.
Residential Rental Property Depreciation Recapture Example
We’re going to show you six steps to calculate depreciation recapture. First, we need to know the tax basis of the property, which is the same as the property’s purchase price plus closing costs and any capitalized expenses. We also need to know the adjusted cost basis which is the purchase price minus the annual depreciation multiplied by the number of years of ownership.
Now, let’s look at a rental property depreciation recapture example in six steps.
1. Purchase a Rental Property
Let’s assume that Jane purchased a residential income producing property for $350,000. Now, let’s assume the property has an annual depreciation of $20,000, and Jane decides to sell the property after 11 years for $430,000.
2. Calculate the Adjusted Cost Basis of the Rental Property
To figure out the adjusted cost basis, we use the purchase price minus the annual depreciation rate multiplied by the number of years of ownership, and we get $130,000.
$350,000 - ($20,000 x 11) = $130,000
3. Calculate the Realized Gain on the Rental Property
Then, we figure out the realized gain on the property by subtracting $130,000 from $430,000, and we get $300,000.
4. Calculate the Capital Gain on the Rental Property
The capital gain will be $300,000 - ($20,000 x 11), which = $80,000, and so the recapture gain is $20,000 x 11, which is $220,000.
5. Know Your Tax Brackets
Now, let’s assume a 20 percent capital gains tax and a 28 percent income tax bracket. The total amount of tax that Jane will pay on the rental property will be (0.20 x $80,000) + (0.28 x $220,000) = $16,000 + $61,600 = $77,600.
6. Calculate the Depreciation Recapture Amount
The depreciation recapture amount is 0.28 x $220,000, which is your tax bracket, expressed as a percentage, multiplied by the recapture gain.
The depreciation recapture amount will be $61,600.
As you can see from the above example, it’s quite complicated, but you were able to figure out the depreciation recapture amount. So, now you know how much you will pay when you sell a property, and you can decide if it’s worth selling and what you need to sell it for.
Now, let’s take a look at a couple of real estate professional’s thoughts on depreciation recapture.
“This is the depreciation recapture tax, and it's designed to make sure you pay back the government roughly what you saved in taxes over the years. Remember that the depreciation expense saved you from being taxed at the ordinary income tax rates, which are up to 37 percent now.”
— Domenick Tiziano, Owner,
“Depreciation recapture usually applies to improved real estate because that real estate will generally increase in value over time while its improvements will depreciate with time and use. The recomputed basis will be used to determine any gain. If there is gain, it will be taxed as capital gain and, if there is a loss, it can be taken as a loss for the taxpayer.”
— Brenda Di Bari, Commercial Real Estate Broker,
Depreciation of Rental Property Frequently Asked Questions (FAQs)
Below, we’re going to answer the most frequently asked questions about real estate depreciation, including rental property tax deductions because depreciation of rental property is one of the largest rental property tax deductions.
What Depreciation Method Is Used for Rental Property?
The depreciation method used for rental property is MACRS. There are two types of MACRS: ADS and GDS. GDS is the most common method that spreads the depreciation of rental property over its useful life, which the IRS considers to be 27.5 years for a residential property.
What Happens to Real Estate Depreciation When You Sell the Property?
When you sell your rental property, you typically have to pay a depreciation recapture tax if you sell the property for more than its depreciated value. The depreciation recapture tax is typically 20 percent plus the state income tax on the depreciation amount that you claimed. However, the exact amount depends on your income tax bracket.
If you want to hold off on paying this depreciation recapture tax, you may want to consider a 1031 exchange. To find out more about a 1031 exchange, read our in-depth guide on section 1031 exchange.
Do You Have to Take Real Estate Depreciation?
You don’t have to take real estate depreciation. However, it’s recommended that you do because it’s one of the main rental property tax deductions. Also, the IRS assumes that you do take depreciation, so will have to pay a depreciation recapture tax when you sell the property whether or not you take the depreciation.
The Bottom Line
Real estate depreciation is a way to expense the costs of your rental property over time and lower your tax burden. Real estate depreciation is based on the type of property and its useful life as determined by the IRS. The IRS’ depreciation schedule for residential real estate is generally 27.5 years and 39 years for commercial property.

November 13, 2018

### Residential Rental Property Depreciation Calculator

How to Read Your Rental Property Depreciation Calculator Results
Cost basis: This is the original purchase price of the property plus all closing costs; if you’re unsure of your closing costs, they’re typically 2 to 5 percent of the purchase price
Averages of rental property depreciation: The useful life of residential rental property is 27.5 years using the general depreciation system (GDS) of the modified accelerated cost recovery system (MACRS).
What’s next: Using the residential rental property depreciation calculator you can determine how much depreciation expense you can deduct from your income each year based on purchase price and useful life, lowering your tax bills each year.
How the Rental Property Depreciation Calculator Works
Rental property depreciation is a process used to deduct the costs associated with purchasing and improving income-producing property. Rental property depreciation happens during the course of the property’s useful life as determined by the IRS’s depreciation method. The rental property depreciation calculator is used by investors to calculate the amount of depreciation per year as well as the total amount of depreciation during the asset’s useful life.
Our rental property depreciation calculator uses straight line depreciation because the alternative is much more complicated. Our free rental property depreciation calculator should serve as a tool to help you estimate your property depreciation amount. However, we still recommend working with a tax professional.
The real estate depreciation calculator shows you how much your depreciation is during the course of one year and the property’s useful life, according to the general MACRS depreciation method. It also displays a graph so you can see your depreciation during the course of multiple years, all the way up to 27.5 years for residential property.
Who a Rental Property Depreciation Calculator Is Right For
A rental property depreciation calculator is right for you if you own one or more residential rental property and want to calculate your expected depreciation on an annual basis or during the property’s useful life of 27.5 years. Our free rental property depreciation calculator shows the amount of depreciation, which can help you maximize your tax savings.
A rental property depreciation calculator is typically right for:
A residential real estate investor who owns single family homes, vacation rental properties or condos
An investor who owns multifamily property which is typically a property with two or more separate residential units
A commercial investor who is an owner-occupant and runs their business from their own commercial property
A commercial real estate investor who owns income-producing commercial real estate like an office building or a shopping center
Real estate investors who want to calculate depreciation on improvements they make to the property such as replacing the roof or renovating a kitchen or bathroom
This rental property depreciation calculator can be used for more than just showing the depreciation of rental property. It can also be used to show the depreciation of improvements made to the rental property. These improvements include things like replacing all of the doors, windows or gutters on a property. The IRS has specific guidelines for what are considered improvements and what you can use as rental property deductions.
This calculator is geared towards residential rental property depreciation, but you can still use it to show the depreciation of commercial real estate for one or more years. However, using the general MACRs method, commercial property typically has a useful life of 39 years, and the calculator only shows depreciation for up to 27.5 years.
If you have further questions about what rental property depreciation is, how it’s used and what MACRS depreciation is, read our in-depth guide on residential rental property depreciation.
Rental Property Depreciation Calculator Inputs
When using our rental property depreciation calculator, you will be prompted to input your cost basis, the recovery period and the month and year the property was placed into service. Below, we’re going to go into more detail about each of these inputs. The inputs are needed so the real estate depreciation calculator can use them to calculate the amount of your depreciation.
Cost Basis
Cost basis is the first input that the rental property depreciation calculator is going to require. Cost basis is simply the purchase price of the property plus your closing costs. The purchase price is how much you actually paid for the property, not necessarily what it was listed for or what it’s worth today. You can find this number on your HUD-1 closing statement.
Your closing costs are the extra expenses that you pay on top of the purchase price of the property. Average closing costs are 2 to 5 percent of the property’s purchase price and include things such as your lender fees, appraisal, rental property insurance, transfer taxes and more. You can also find these on your HUD-1 closing statement. However, if you’re not sure what your closing costs are, the calculator gives you a range from 2 to 5 percent from which to choose.
Recovery Period
The next rental property calculator input is the recovery period. This is the length of time the IRS requires you to depreciate the asset. If you want to depreciate your residential rental property, then the recovery period input is 27.5 years, which the calculator has auto-filled. However, if you instead want to depreciate an improvement made to the property, then you can select your own input from one to 27.5 years.
Most large improvements such as a roof, replacing all of the windows or all of the doors on a residential rental property have a useful life of 27.5 years. This means they’re depreciated over 27.5 years just like residential rental property is. However, if you have vehicles or furniture or other items that you want to appreciate you will need to find out what their useful life is. You can find this information from IRS Publication 946 or by consulting with your tax professional.
Placed in Service
The next thing that you need to put into the calculator is the month and year the property was placed in service. This is important as it allows the rental property depreciation calculator to use this date and then go forward 27.5 years or however many years the property's useful life is.
The term placed in service doesn’t refer to when you purchased the property. Instead, it refers to when you first rented out the property. You should be able to find this information from your files containing residential lease agreements for the property.
Rental Property Depreciation Calculator Outputs
After you put all of your inputs into the calculator, it will use them to calculate the rental property depreciation amount per year and over 27.5 years of the property’s useful life. You can then use the depreciation amount to know more about your rental property tax savings. You can also use it help you know how much of your rental property improvement costs are being offset each year.
Rental Property Depreciation Amount
The calculator's purpose is to calculate an output which is the rental property depreciation amount. This is the amount of rental property depreciation per year to deduct from your taxable income. The rental property depreciation calculator also shows the amount of rental property depreciation during the property’s useful life. As we previously mentioned, this information is also shown in an easy-to-read graph.
Once you have the outputs from the residential rental depreciation calculator, be sure to keep track of this information for use in future tax filings. One of the best ways to keep track of this information is by using real estate account software. Check our list of the Best Real Estate Accounting Software to see which is best for you.
Pros and Cons of Using Rental Property Depreciation
There are both advantages and disadvantages of using rental property depreciation. One of the main pros of rental property depreciation is that it is a way to offset the expenses of owning and maintaining income-producing property. However, one of the cons is that MACRS depreciation can be complicated and you need to follow the IRS’s depreciation guidelines.
“Typically, if your personal tax bracket is 25 percent or above, then depreciation of rental property can be a good thing. This is because the IRS taxes any amount you depreciated over the life of your rental when you sell it. For every dollar you depreciate now, the IRS wants to tax you at a flat rate of 25 percent when you sell. This is commonly referred to as Depreciation Recapture tax.”
— Robert Taylor, Owner,
Rental Property Depreciation Pros
Pros of rental property depreciation include:
It’s a major tax savings because it lets you offset the costs of both your property and qualified improvements during a period of time
It lets you offset the costs of the normal wear and tear that your property goes through
Depreciation may produce a yearly loss which you can deduct against your rental income
Rental Property Depreciation Cons
Cons of rental property depreciation include:
Having to essentially pay back some of the tax savings of depreciation once you sell the property through what is called depreciation recapture
Rental property depreciation can be difficult to understand and time-consuming to calculate
Not all types of property and improvements qualify for depreciation, so you need to know which ones do; for example, your primary residence doesn’t qualify and neither do property repairs such as fixing one or two broken windows
Tax Advantage Alternatives to Using Rental Property Depreciation
You’re not required to take rental property depreciation. However, whether you take depreciation or not, once you sell the property you will have to pay depreciation recapture on the property. This is basically a way for the IRS to recover some of the money you received in tax savings once you sell the property.
If your property or other asset doesn’t qualify for depreciation or you choose not take it, there are alternatives:
Rental property tax deductions: The IRS allows tax deductions on all legitimate expenses related to running a rental property; these expenses can be deducted yearly, unlike depreciation; for example, you can deduct money you spent on fixing a leak or patching a roof
1031 exchange: A 1031 exchange helps investor defer capital gains tax by selling your investment property and rolling your capital gains (profits) over into purchasing a new like-kind property
“1031 Exchanges are a great way to delay paying tax on the profits made when selling a rental property. With a 1031 Exchange, you can ‘roll’ your profits into a new property and avoid paying tax on the sale. Be sure to contact a CPA [certified public accountant] who is knowledgeable in real estate. He or she can help you navigate the ins and outs of a 1031 as well as depreciation and deductions.”
— Kevin Ortner, CEO, Renters Warehouse
If you’re interested in doing a 1031 exchange and need a company to help you complete the exchange, check out our guide to the best 1031 exchange companies.
The Bottom Line
Residential rental property depreciation is a complex subject, and the calculations around depreciation can be confusing. Our free rental property depreciation calculator can do the calculations for you based off of the data you input. It will calculate the depreciation amount of your rental property each year and during the use life of the asset you’re depreciating.

November 10, 2018

### Cap Rate vs. ROI vs. Cash-on-Cash Returns: A Real Estate Investors Guide

Real estate investors frequently use three metrics to measure the performance of an income-producing property: capitalization (cap) rate, return on investment (ROI) and cash-on-cash returns. It’s recommended to use all three to get the best understanding of a property’s potential rate of return. The ROI formula is annual return divided by total investment.
When to Use Real Estate Investment Formulas
Typically, the more information you have about a property, the more informed a decision you make in regard to purchasing it or keeping it in your portfolio. For that reason, using all three formulas is recommended. However, there are situations when you may be short on time or just want a quick formula to analyze a property’s rate of return so just want to use one formula.
Cap Rate
Cap rate measures the rate of return on a property. You can calculate a property’s cap rate by using the cap rate formula, which is net operating income divided by current property value. Cap rate is typically used as a way to compare two similar properties in the same property class — for example, two commercial buildings.
Generally, buy-and-hold investors will look at that cap rate to see how well the property is performing during a one-year period. However, cap rate can’t be used on fix-and-flip properties because there’s no rental income. Keep in mind that cap rate also doesn’t take into account mortgage payments.
Return on Investment
ROI is used to determine how well your piece of real estate is performing. It’s generally considered your annual return divided by your total investment. Typically, the lower your cost, the higher your ROI. You can use ROI on both fix-and-flip and buy-and-hold investments and the ROI formula allows for your mortgage to be considered, which isn’t the case with the cap rate formula.
Cash-on-Cash Returns
Cash-on-cash return is a real estate metric that analyzes the performance of your asset. It also takes into consideration the debt on a property, such as your mortgage, similar to ROI but different from using a cap rate. The cash-on-cash return formula can vary but is generally your net operating income divided by your total cash investment, and it includes things like your lender fees and closing costs.
Cap Rate vs. ROI vs. Cash-on-Cash Returns
Whether to use cap rate vs. ROI or cash-on-cash returns is something that real estate investors have to decide when evaluating properties. Typically cap rate is used on multifamily properties, commercial buildings and apartment buildings. It’s not used on fix-and-flip properties because net operating income (NOI) is used in the cap rate formula and there isn’t any NOI for a fix-and-flip project because there’s no rental income.
Investors typically use cap rate to compare properties, in addition to also using cash-on-cash returns, comparable property sales prices and ROI. Conversely, investors use ROI to analyze both long-term investment properties as well as fix-and-flip properties. The ROI is the overall rate of return on a property including debt and cash invested. ROI does take the debt on the property into consideration.
Both commercial and residential investors typically use cash-on-cash returns to evaluate the cash flow coming in from income producing properties. However, it typically isn’t used by fix-and-flip investors since they don’t have any monthly rental income. Cash-on-cash returns typically provide a more accurate analysis of the investment property’s performance when compared to the property’s ROI. This is because cash-on-cash returns only measure the return on the actual cash invested and doesn’t include the debt.
How to Calculate Cap Rate on an Investment Property
Investors can calculate cap rate by hand or by using a cap rate calculator. To calculate cap rate by hand, you simply divide the property’s NOI by the current property value and multiplying it by 100 to get a percentage. The cap rate typically measures the property’s rate of return over a one-year period. Unlike ROI, it’s only used on income-producing properties and usually properties with more than one unit.
When you’re calculating the cap rate, keep in mind that it’s calculated based on annual returns. This means if a property performed well or poorly for one year, this will show up in the cap rate calculation. It also means that an investor isn’t getting a full overview of the property for the past several years.
For example, if the property had a few prior years of poor performance the cap rate may be deceiving in that is only shows one positive year of returns. That’s why it’s important to use more than one metric when evaluating an investment property.
For a more in-depth look, including what a good cap rate is, read our capitalization rate article.
Cap Rate Formula
Cap Rate Formula = NOI / Property Value x 100
For the first part of the cap rate formula, we need to find out what the NOI is. This is the amount of cash flow generated by an investment property after subtracting operating expenses, but before principal and interest payments, capital expenditures, depreciation and amortization.
Next, you find out the property value, by having a real estate agent conduct a comparative market analysis or getting the property appraised. You can also get a rough estimate of what your property is currently worth on sites like Zillow. Then, you multiply that number by 100 to figure out the cap rate. A good cap rate is typically 4 to 7 percent or higher, although it does depend on property class and location.
Cap Rate Example
Now that we know what the cap rate formula is, let’s look at an example. Let’s assume that we want to figure out the cap rate on an apartment building in an area that has average cap rates of 7 percent.
Let’s assume the NOI of the apartment building is $80,000, and the apartment building is worth $1.2 million.
First, we divide the NOI by the property value.
$80,000 / $1,200,000 = 0.067
Then, we multiply by 100 to get a 6.7% cap rate.
Now, we can use that cap rate to compare it to the average for apartment buildings in the area and decide that the NOI is low for that building, or we may want to offer a lower purchase price so that the cap rate will be more in line with the 8 percent average in the area.
How to Calculate ROI on an Investment Property
An alternative or addition to calculating cash-on-cash returns and cap rate, is calculating your ROI. Concerning real estate, ROI is your return on your total investment in the property. It includes both the cash you invested and any debt that you leveraged on the property including things like an investment property loan.
ROI differs from cap rate because it considers your mortgage payment in the formula. It also differs from cash-on-cash returns because it takes into consideration, not just the cash you spent for the downpayment and lender fees but also the amount of money you financed.
ROI can be skewed because it appears as if your return on investment is greater when you have a mortgage than if you paid using all cash. This is why it’s so important to use more than one way of analyzing an investment property before you purchase it.
ROI Formula
ROI = Annual Return / Total Investment x 100
Generally, investors calculate their annual return by subtracting their property related expenses from their total rental income to get their NOI. Then, you divide this by your total investment, which is how much you have in the property including cash and debt. Finally, you multiply that number by 100. Typically, a good ROI is anything above 10 percent on an investment property and more than 15 percent on a fix-and-flip.
ROI Example
Let’s take a look at an example of an investor using the ROI formula to decide if they want to purchase a duplex.
Let’s assume that the annual return of the duplex is $24,000, and the total investment needed to purchase the duplex is $150,000.
First, we divide the annual return by the total investment, and then multiply by 100 to get a percentage.
$24,000 / $150,000 x 100 = 16% ROI
The 16 percent figure is considered to be a high ROI on an income producing property. Once you know the ROI, you can compare it to other ROIs on similar properties in the area, and you can compare it to other investment options to see which will yield you the highest return.
How to Calculate Cash-on-Cash Returns on an Investment Property
Cash-on-cash returns measure the return on the actual cash invested into the investment property. It’s also referred to as the cash yield on an investment property. Investors who pay all cash for a property often use cash-on-cash return as a quick tool to see their rate of return.
Cash-on-cash returns can help investors prescreen a property. It’s also an easy way to compare properties based on a relatively simple calculation. This is in comparison to ROI, which is more complex and takes more time and more knowledge about the property.
Besides measuring the current return, the cash-on-cash return can also be used to forecast future cash distributions of an investment property. Keep in mind that it’s not a guaranteed future return but, instead, investors use it as a targeted future return and as an estimate of what the property will produce in the future.
Cash-on-Cash Returns Formula
Cash-on-Cash Return = Annual Pretax Cash Flow / Actual Cash Invested x 100
The cash-on-cash return formula is generally considered to be one of the most used and simple real estate investing formulas. Cash-on-cash return equals the annual pretax cash flow divided by the actual cash invested multiplied by 100.
To figure out your annual pretax cash flow, you add your gross scheduled rent plus any additional property derived income minus your vacancy minus operating expenses. Now, for the next part of the equation, you need to know how to calculate your actual cash invested. You do this by adding together any cash you invested in the property including your down payment, closing costs and property repairs.
Cash-on-cash returns can be used in addition to cap rate and ROI to find out how well a rental property is performing, if it’s a good value and how the subject property compares to other properties. Typically, 8 to 12 percent is considered a good cash-on-cash return. Keep in mind, that this number is skewed if you finance the property, and you need to make sure you can afford the monthly mortgage payments.
Cash-on-Cash Returns Example
Let’s look at an example of an investor using cash-on-cash return to decide if she wants to purchase a duplex. Let’s assume that you know that your actual cash invested is $75,000 which is your down payment, closing costs and rehab costs. Now, let’s assume that your annual pretax cash flow is $12,000.
You divide your annual cash flow by your total cash invested and then multiply by 100.
$12,000 / $75,000 x 100 = 16% cash-on-cash return
This is considered a high cash-on-cash return, so it would most likely be a good property to invest in. However, you should factor in your financing costs if you finance the property and look at the cap rate and ROI as well.
Pro Tips on Using Cap Rate vs. ROI vs. Cash-on-Cash Returns Formula
Cap rate vs. ROI and the cash-on-cash returns formula can get a little bit confusing when analyzing real estate. Remember, that we recommend using all three metrics as much as possible when figuring out the rate of return and performance of an income producing property.
Here, we have a few thoughts from the pros on cash-on-cash returns and cap rate vs. ROI.
1. Use Cap Rates to Compare Similar Properties
When investors use cap rates to analyze income-producing properties, they need to compare apples to apples. This means that they need to compare properties cap rates by the location they’re in, as well as the property class. For example, a duplex in the countryside shouldn’t be compared to an office building in a metropolitan area.
“Cap rates are useful for investors to compare between projects; however, it’s not always black and white. For example, an investor may have a lower cap rate in a top market and a higher cap rate in a submarket. Therefore, while one can compare the cap rates for each project, other factors must be taken into consideration before making a decision.”
— Puja Talati, Partner, Enzo Multifamily
2. Use the Same Calculations to Compare Real Estate Investments
It doesn’t do you much good if you use different calculations on different properties and then compare them, expecting the results to help you make a purchase decision. It’s recommended to use the cap rate, ROI and cash-on-cash returns for each property. However, if you only use one, make sure it’s the same one for each property you analyze and compare.
“I think the most important thing to realize is just to make sure you’re using the same calculation when comparing investments. So, for example, don’t look at the ROI on one investment and compare that to the cash-on-cash return of another investment. Make sure you are either comparing the ROI of both of them or the cash-on-cash return of both of them.”
— Cornelius Charles, Co-owner, Dream Home Property Solutions, LLC
3. Use a Combination of Investment Formulas to Compare Properties
Cap rate, ROI and cash-on-cash returns can each stand on their own when analyzing and comparing investment properties. However, the most accurate results come from using all three formulas.
“Cap rate and cash-on-cash returns are both important metrics to consider when evaluating real estate investments. Both of these numbers are ways to determine the ROI of a real estate investment. Specific to multifamily, I suggest using a combination to evaluate any deal.”
— Veena Jetti, Founding Partner, Enzo Multifamily
Cap Rate vs. ROI Frequently Asked Questions (FAQs)
Below, we’re going to address some of the most frequently asked questions on cap rate vs. ROI, how to calculate ROI and the cash-on-cash return formula.
What Is a Good Cap Rate?
A good cap rate depends on the property type, location and net operating income. Generally, investors want a cap rate above 4 percent on residential real estate and more than 7 percent on commercial real estate. A higher cap rate is generally preferred because it means the property’s fair market value is relatively low compared to the NOI.
What Is the Cash-on-Cash Return Formula?
Most real estate investors use the following cash-on-cash return formula: Net operating income divided by your total cash investment. As we mentioned above, your net operating income is your potential rental income plus other income minus vacancy losses -minus total operating expenses.
How to Calculate ROI on a Fix-and-Flip Project?
The ROI formula is simply your annual return divided by your total cash investment. However, calculating the ROI for a fix-and-flip is difficult because you have to work backward to get the variables. These include the property’s acquisition, rehab and sales and marketing costs. To make this easier, check out our free house flipping calculator.
What Is a Cap Rate Calculator?
A cap rate calculator is a tool that helps investors determine the rate of return on their real estate investment. It includes inputs like property value, gross annual rental income, operating expenses and vacancy rate. After the investor fills in the inputs, the cap rate calculator will give an output of your capitalization rate.
The Bottom Line
Real estate investors use different formulas to analyze how income-producing properties are performing and to make decisions on whether they should buy or lease commercial real estate. Investors often debate if they should use cap rate vs. ROI in their analyses. However, it’s typically best to use cap rate, ROI and cash-on-cash returns to get a comprehensive financial picture of the property.

October 8, 2018

### Free Net Operating Income (NOI) Calculator

How to Read Your NOI Calculator Results
The rules of thumb for net operating income are typically:
NOI should be positive on an income-producing property.
NOI is typically calculated on a yearly basis.
NOI does not include your monthly mortgage payments.
NOI is typically used to figure out cap rate, ROI, and cash flow to evaluate a property you’re investing in.
How the Net Operating Income Calculator Works
The net operating income calculator determines a property's NOI by calculating data inputs, including gross rental income of your investment property, other income, vacancy losses, and operating expenses. The calculator will then use those inputs to tell you the property’s net operating income.
The calculator is easier than doing the calculations on your own, but in case you’re curious, we will provide you with the net operating income formula. Keep in mind that NOI is typically calculated on a yearly basis, so you may need to multiply your monthly rents and expenses by 12.
Let’s take a look at an example of how to calculate net operating income on an investment property. Remember that the NOI formula is gross rental income + other income - vacancy loss - operating expenses. Let’s assume that the gross rental income is $120,000 per year, other income is $12,000 per year, vacancy loss is $6,000 per year, and operating expenses are $40,000.
First, let’s figure out the total yearly income
$120,000 + $12,000 = $132,000
Then we subtract the vacancy loss
$132,000 - $6,000 = $126,000
Next, we subtract the operating expenses
$126,000 - $40,000 = $86,000 NOI
This is for year one, but it would continue to be the same if nothing changes, which would double your available cash in year two. The NOI shows you if the property has the potential to be profitable. Remember that it doesn’t include your monthly mortgage payment. After you calculate your NOI, you can use it to calculate cap rate, which is the rate of return on an income-producing property; cap rates of 4 percent to 10 percent and up are typically considered good.
It’s important to know your NOI so you can compare it to the NOIs of other properties; you can work to increase it to maximize your cash flow and use it to figure out the property’s cap rate and ROI. Typically, a higher NOI is the right property to choose, but you should also consider the property’s cash flow after your mortgage payment is factored in.
For more information on net operating income, the net operating formula and how to calculate it, check out our in-depth guide on net operating income.
Net Operating Income Calculator Inputs
When using the net operating income calculator, you will be prompted to enter certain inputs. These inputs include your gross rental income, other income, vacancy loss, and your operating expenses. We will explain each input for the net operating income calculator below.
Gross Rental Income for Investment Property
The first input needed for the net operating income calculator is your gross rental income. This is the combined total rent under the terms of each individual residential or commercial lease, assuming that the property is 100 percent occupied. If the property is not fully occupied, then the amount is referred to as potential rental income (PRI), and it’s based on a rental market analysis, according to the leases and terms of comparable properties in the area.
Other Income for Investment Property
The next input is other income, which refers to any additional income that the property generates (besides rental income). This can include things like parking, vending, and laundry income, as well as facility rentals and billboard or sign income. Basically, you should include all revenue streams coming from the income-producing property.
Vacancy Loss on an Investment Property
Vacancy loss is the loss of income due to tenants vacating the property and/or tenants defaulting on their lease payments. The vacancy loss can be calculated based on current lease expiration dates, and you can use vacancy rates for comparable properties if you’re not sure what your vacancy loss will be.
To calculate vacancy losses, look at what that unit could have rented for and multiply it by however many months out of the year it was vacant. For example, if other similar units rent for $3,000 per month and the vacant unit was empty for two months, you would multiply $3,000 by 2 and get $6,000, which is the yearly vacancy loss for the property.
Operating Expenses of an Investment Property
Your operating expenses are all of the expenditures needed to properly operate and maintain your income-producing property. The net operating income formula uses your total operating expenses, which you can calculate by adding up all of your separate operating expenses (such as property taxes and rental property insurance).
Operating expenses on a rental property usually consist of:
Property Taxes: Generally assessed annually and if you have a mortgage, your lender may escrow them and they will be paid monthly with your mortgage payment. You can find the amount of your property taxes from your local property tax office, Zillow, or on your yearly tax assessment statement.
Rental Property Insurance: Also known as landlord insurance, it is different from homeowners insurance, and a policy should include loss of income, liability and perils coverage. An average rental property insurance policy costs $1,473 to $1,596 per year.
Property Management Fees: Fees charged by a property manager or management company to manage your property. The property manager typically collects rents, communicates with tenants, and coordinates maintenance and repairs. Management fees vary based on property location, property size, and scope of work, but typically range from 8 percent to 12 percent for an investment property and 25 percent or higher for a vacation rental property.
Maintenance and Repairs: Things needed to upkeep an investment property, such as lawn care, snow removal, pest control, cleaning, etc. They also include repairs as needed, such as pointing bricks, replacing a leaky roof, or fixing faulty wiring. Maintenance and repairs typically account for 1 percent of the property’s value per year.
Miscellaneous Expenses: Anything that you spend on the property that doesn’t fit into another operating expense category. This could be things like accounting, marketing, advertising, and legal fees. If you’re not sure what these expenses are, you can leave this field blank in the net operating income calculator.
Net Operating Calculator Outputs
Based on all of your inputs, the free net operating income calculator figures out the net operating income of the property. Once again, the net operating income formula that the calculator uses is NOI = Gross rental income + Other income - Vacancy loss - Operating expenses.
Net Operating Income
After you enter your inputs, such as gross rental income and operating expenses, the calculator will tell you your net operating income. You can then use this NOI to figure out your cap rate and cash flow, which are two additional ways to analyze an income-producing property.
Conversely, the NOI can also be helpful with a property you already own. It can help you figure out if your rents are too low, vacancy losses are too high, or operating expenses are too high.
When to Use a Net Operating Income Calculator for Real Estate
Net operating income is primarily used by buy and hold real estate investors to analyze an income-producing property and decide if it’s a good investment and whether or not they want to purchase it. By looking at the NOI of a few different properties, you can compare them to see which has the highest NOI in comparison to its sales price.
The net operating income calculator will easily calculate a property’s NOI based on inputs such as gross rental income and operating expenses, thus making it a valuable tool for both investors deciding if a property is worth the investment and investors who want to analyze their current property to try to increase their NOI or get the property ready to sell.
“I mostly use NOI to understand how my units are performing financially over time. If I see that NOI is slipping, I can take corrective action by analyzing it further. Is it down because of longer vacancies, higher maintenance costs, higher property taxes, etc.? Knowing the drivers of NOI and how to continuously improve it will make my rentals more profitable and ultimately more valuable to another investor should I ever want to sell.” - Domenick Tiziano, Blogger, Accidental Rental
A net operating income calculator can be used by the following types of investors:
Residential Real Estate Investors: To compare the NOI of different properties and decide which one is worth purchasing
Commercial Real Estate Investors: To analyze commercial income-producing properties and find one that is a good investment based on the NOI, cap rate and sales price
A net operating income calculator can be used for the following types of properties:
Current Investment Property Owner: Analyze current NOI to do a financial check on their property and see how they can raise their NOI to increase cash flow
Prior to Selling an Investment Property: You can see what your NOI is and find ways to improve it (e.g., raise rents, lower vacancy rates, etc.) so you can list it for a higher sales price
Apartment Buildings: You can find out what your cash flow will be based on the NOI of an apartment building; because there often aren’t good comparables of apartment buildings due to the small market sector, NOI can help you compare available inventory
Multifamily Properties: NOI can also help you compare multifamily properties and help you determine if it makes sense to invest in one
A net operating income calculator generally isn’t used by fix and flippers because they don’t intend to rent out their property. Instead, they would analyze an investment property by looking at the comparable property prices, the loan to value (LTV) and the after repair value (ARV).
Alternatives to Using NOI for Real Estate Investments
Knowing the net operating income of an income-producing investment property helps you analyze the property and make a purchase decision. However, there are also alternative ways of deciding if an investment property is right for you.
If the property isn’t fully rented, you’re not sure what the rents should be, or the property needs to be rehabbed, there are alternative ways to analyze an investment property. We recommend using two to three methods so you get a well-rounded financial picture of the property.
Some alternative to using NOI for real estate investments include:
Cap Rate: This actually includes the NOI, and is used by investors to help determine the potential rate of return on an investment property. The cap rate formula is NOI divided by the current property value.
The 1 Percent Rule: The gross monthly rental income should be a minimum of 1 percent of the purchase price. Some investors use the 2 percent rule, depending on the property type and location. If the property’s gross monthly income is 1 percent or more of the purchase price, it's usually cash flow positive.
Gross Rental Yield: This number can be found by dividing the annual rent collected by the total property cost and then multiplying by 100. The total property cost includes the purchase price, closing costs, and any renovation costs.
Cash Flow: Evaluate the property’s potential cash flow by checking to see if the expected monthly rent will cover your costs, including mortgage payment, taxes, insurance, utilities, and HOA fees.
Comparable Properties: Look at what other comparable properties have sold and rented for in the past three to six months. Comparables should be the same type of property, have similar amenities and be similar in size. They can be found by running a comparative market analysis.
Return on Investment (ROI): Typically 10 percent or more is a good ROI for a real estate investment. You can figure out your ROI on an investment property by calculating your annual return and dividing that by your total cash investment. You can figure out your annual return by subtracting your expenses from your total rental income.
Bottom Line
Net operating income can be calculated in different ways, but the generally accepted method is gross rental income plus any other income minus vacancies minus operating expenses equals net operating income. Real estate investors use NOI to help analyze income-producing properties. Our free NOI calculator helps figure out the calculations for you.

September 24, 2018

### Net Operating Income for Real Estate Investors: How to Calculate NOI Formula

Net operating income (NOI) is a calculation of the income generated by a real estate investment. It measures the amount of cash flow generated by an investment property after operating expenses but before principal and interest payments, capital expenditures, depreciation, and amortization. Investors use NOI to determine the value and profitability of an income-producing property.
What Net Operating Income Is
In real estate investing, net operating income is the amount of income collected from an investment property after you subtract the operating expenses and vacancy losses. Real estate investors look at a property’s net operating income to determine if the property is a good investment.
They also analyze the NOI of a property that they already own to help determine if they need to raise rents to increase their cash flow. Unlike with the cap rate, there isn’t a "good" NOI. Instead, investors can compare the NOIs between properties and use the current NOI to see if their expenses are too high, rents too low, or if the property is unaffordable once they add in their mortgage payment.
Net operating income is generally calculated on an annual basis. So, if you know what your monthly income and expenses are, you just multiply by 12 to get your yearly totals. Keep in mind that NOI should be used in addition to other evaluation tools, such as cap rate, return on investment (ROI), comparable properties rental income, and cash flow. We recommend using NOI and one of the other tools to understand the investment property’s overall financial standing better.
How to Calculate Net Operating Income
You can calculate NOI for your real estate investment by using the generally accepted net operating income formula, which is your potential rental income plus any additional property-related income minus vacancy losses minus total operating expenses.
Keep in mind that the net operating income formula can vary depending on who’s calculating it. For example, most investors separate potential rental income and other income but, sometimes, you will see them combined. Regardless, the generally accepted net operating income formula is your potential rental income plus any additional property-related income minus vacancy losses minus total operating expenses.
Using an NOI calculator will make it much easier, so check out our free net operating income calculator.
Net Operating Income Formula
The net operating income formula:
NOI = Rental income + Other income - Vacancy losses - Total operating expenses
To figure out a property’s net operating income, you need to know the potential rental income and other income it produces. You also need to account for vacancy losses from vacant units or units where tenants aren’t paying rent. Lastly, you need to add up all of your operating expenses. Once you have all of those numbers, you can calculate the net operating income of investment property.
To find your net operating income, you typically need the potential rental income of investment property, vacancy losses on investment property, other income on investment property, and total operating expenses on investment property.
Potential Rental Income of Investment Property
Potential rental income (PRI) is the combined total rent under the terms of each individual residential or commercial lease, with the assumption that the property is 100 percent occupied. If the property is not fully occupied, then the amount of PRI is based on a rental market analysis, according to the leases and terms of comparable properties.
Vacancy Losses on Investment Property
Vacancy losses represent the loss of income due to tenants vacating the property and/or tenants defaulting on their lease payments. The vacancy factor can be calculated based on current lease expirations. Market-driven figures using comparable property vacancies can also be used for the purpose of calculating a property’s NOI.
To calculate vacancy losses, look at what that unit could have rented for and multiply it by however many months out of the year it was vacant. For example, if other similar units rent for $2,000 per month and the vacant unit was empty for three months, you would multiply $2,000 by 3 and get $6,000, which is the yearly vacancy loss for the property.
Other Income on Investment Property
Because there are many different ways a property can generate income, real estate investors need to include all possible revenues in their calculation, in addition to the monthly rent. These other revenues include, but are not limited to, facility rental proceeds as well as proceeds from vending machines, proceeds from laundry services, income generated from parking fees, billboard/signage fees, and other relevant service charges.
Total Operating Expenses on Investment Property
Total operating expenses include all necessary expenditures associated with operating and maintaining investment property. To get the total operating expenses, you add up all of the operating expenses like property taxes, maintenance, and management fees.
Specifically, operating expenses typically include:
Property taxes: These are assessed by a governing authority in the area the property is located and vary based on location, property value, and size.
Rental property insurance: This helps protect your property from loss of income, damage, and perils like weather-related damage. The average policy on a $200,000 rental property costs $1,473 to $1,596 per year.
Property management fees: These fees are charged by a property manager or management company and can vary from 8 percent of gross collected monthly rent for investment property to more than 25 percent of gross rent for a vacation rental property.
Maintenance and repairs: These include things to keep the property maintained, like pest control, painting, and lawn care, as well as any necessary repairs. Expect to pay about 1 percent of the property value per year on maintenance-related expenses.
Miscellaneous expenses: These can include things like legal fees, marketing and advertising expenses, and anything else needed to operate the property that doesn’t fall under another category.
Expenses Not Included in NOI
It is important to note that debt service, depreciation, leasing commissions, tenant improvements, repairs to wear and tear, income taxes, and mortgage interest expenses are not included in calculating net operating income. This is because NOI is unique to the property itself and does not include other expenses that are specific to the investor/borrower.
When to Use Net Operating Income
Before a purchase, an investor can use NOI to assess a property’s value, helping them make a more informed investment decision. After the purchase, NOI can be used as a measure of operating cash flow.
Lenders who finance investment property are also interested in knowing the net operating income of the property. This is because NOI is sometimes used as one of the deciding factors in approving a commercial loan for real estate investors. Lenders will look at a property’s net operating income and assess if the owner will have enough cash flow to pay the mortgage payments. Lenders take this seriously because they want to ensure the borrower can afford to repay the loan.
“NOI is especially important to commercial lenders on multifamily assets because their risk is assessed based on the NOI of the subject property. On large multifamily units, lenders, such as Fannie Mae, use the NOI metric when assessing the initial value of the property instead of evaluating the borrower or investors credit risk and history.”
―Veena Jetti, Founding Partner, Enzo Multifamily
Calculations That Involve NOI
NOI is used in many calculations and formulas used by real estate investors. It’s used by investors to evaluate investment property’s ability to produce cash after operating expenses are paid.
Some of the calculations that rely on NOI include:
Cap rate: Shows a property’s potential rate of return; the cap rate formula is NOI / property value x 100.
ROI: This is the return expressed as a percentage that you receive on investment property; the ROI formula is annual return / total investment and the annual return also is known as the NOI.
Debt service coverage ratio (DSCR): Used by lenders to see if a property’s income covers its operating expenses and debt payments after calculating its NOI.
Cash return on investment: The amount of cash you invest in a property compared to the amount of cash you receive, taking into account its NOI.
Examples of When Net Operating Income Is Used in Real Estate
The net operating income formula is used by both real estate investors and lenders. They each want to evaluate a deal and see if it makes sense. Let’s look at two examples: one where an investor uses NOI to determine if they should buy a property and one example where a lender uses the NOI formula to decide if they should lend money for investment property purchase.
Keep in mind that the net operating income formula is:
NOI = Potential rental income + Other income - Vacancy losses - Total operating expenses
NOI Example
Let’s assume Jane wants to buy investment property. She knows that the potential rental income is $40,000 per year, additional income is $2,000, vacancy losses are $5,000, and operating expenses are $8,000.
First, add up the gross rental income and the additional income: $40,000 + $2,000 = $42,000
Then. subtract the vacancies and operating expenses: $42,000 - $13,000 = $29,000
So, the NOI = $29,000
Jane can then use this number and compare it with other properties in the area and see if the property is priced right. She can also find out her estimated monthly mortgage payment and make sure she can afford it based on the NOI. Jane can use the NOI to figure out the property’s cap rate. The cap rate formula is the NOI divided by the property value, and this is used to help evaluate the rate of return on the investment property.
How Lenders Use NOI in Underwriting
Now let’s look at how lenders look at net operating income when deciding if they’re going to fund an investment property purchase. Let’s use the same numbers from example one, so the NOI = $29,000.
A mortgage lender will adjust this NOI based on the fair market value of rents in the area and check to make sure the vacancy losses are accounted for. They usually "play" with the numbers to get the most conservative NOI. They want to minimize their risk and want to account for any rents that may go down or any units that may become vacant based on average vacancy rates.
A lender will also use the net operating income formula to calculate the debt service coverage ratio. The DSCR is the NOI divided by the annual mortgage payment. This helps a lender evaluate if the borrower can afford to repay the loan. Lenders use this ratio when issuing multifamily, commercial, and business loans.
Pros and Cons of Using Net Operating Income
The calculation of a property’s net operating income is an important way to determine its value as well as evaluate its profitability. Still, the use of NOI in making decisions about a real estate investment has both its advantages and its disadvantaged. Let’s look at the potential pros and cons of NOI below.
Pros of Using NOI
Advantages of using NOI include:
NOI determines an investment property’s initial value, helping real estate investors identify whether it will make a good investment
The use of NOI provides an overview of a property’s ongoing operating revenue
NOI also helps lenders and creditors determine whether a property generates sufficient cash flow to cover any potential debt service
Cons of Using NOI
Disadvantages of using NOI include:
NOI analysis can be manipulated since a property owner can choose to accelerate or defer certain expenses
The NOI of a property is not always constant—it can change depending on how the property is managed
Because other expenses are not considered in NOI, such as interest expense, debt service, income taxes, or capital expenditures, the actual cash flow that a property can generate may differ after all these other expenses are paid
If projected rents are used to calculate NOI, it can throw off the net operating income formula if these rents differ from market rents
How to Improve Net Operating Income
A property with a high net operating income is typically a good thing. A positive NOI means a property’s operating revenues are higher than its operating expenses. A negative NOI indicates that the operating expenses of a rental property exceed its revenues. To help figure this out, there are different methods to improve the NOI of a real estate investment.
The three ways to improve an investment property’s net operating income are to improve rental income, find additional income sources, and minimize operating expenses.
Improve Rental Income
The main source of revenue from an investment property is its rental income. One way to improve your rental income is to make sure that you have a high occupancy rate of 90 percent or above. Another method is to review your rental rates to make sure that the rent is priced properly according to its comps and its target tenant demographic.
If you’re not sure if your rents are too high or too low, check out our guide on what to charge for rent in 2018. It will help you determine how to set a fair rent price that attracts tenants and gives you positive cash flow.
Find Additional Income Sources
Besides rental income, many real estate investors take advantage of additional streams of revenue from their investment properties. Some popular sources of income for rental properties include parking, coin-operated laundry facilities, and vending machines. You may also consider renting out extra space to tenants for storage. If you own a multistory apartment building, you may be able to rent out space to a billboard company.
Some other creative ways to earn additional income on an investment property include:
Charge an extra monthly fee for cleaning services
Charge monthly pet rent
Rent fans and window A/C units to tenants during warmer months
Put higher-end appliances in units for an additional monthly fee
Upgrade kitchens and bathrooms for additional rental income
Minimize Operating Expenses
A property’s operating expenses have a big impact on its net operating income. Therefore, it’s a good idea to cut or trim operating costs when you can. For instance, you can reduce costs on utilities by ensuring that unused lights are turned off or are on a preset timer so that they only come on when it gets dark. You can also pass janitorial expenses through to the tenants as maintenance fees instead of absorbing it as an amenity.
Additional ways to minimize operating expenses include using low-energy light bulbs, such as LEDs. These cost more than regular light bulbs upfront but save money on electrical expenses over the long term. If you pay the water bills on a property, you can cap it at a certain amount and, if the tenants go over that, then it’s their responsibility.
Net Operating Income Frequently Asked Questions (FAQs)
Below we have a few of the most commonly asked questions about NOI pertaining to real estate investing.
Is My Mortgage Payment Part of NOI?
Mortgage payments or any type of financing costs aren’t included in the net operating formula. Net operating income takes into account all rental income and then subtracts vacancies and all operating expenses. A mortgage payment isn’t considered an operating expense. Instead, operating expenses include things like taxes, rental property insurance, and property management fees.
Are Property Management Fees Part of the Net Operating Income Formula?
Property management fees are considered an operating expense, so they are part of the net operating income formula. You would subtract all operating expenses, including the property management fees, from the gross rental income to calculate the net operating income for a real estate investment.
How Do I Calculate NOI?
There are a few ways that real estate investors calculate NOI, but the simplest one is to add up all of your income on the property, including rental income, parking, and laundry, and then subtract your vacancies and your operating expenses. You can also use a net operating income calculator and input things like gross rental income and operating expenses The calculator will use those inputs to generate your net operating income.
Is Net Operating Income Only Used in Real Estate?
Net operating income is used in real estate investing, but it’s used in many other industries as well. NOI is one method that can measure a business’ profits, which typically are reported on an income statement. The net operating income formula varies outside of real estate, but typically is total operating revenue minus total operating expenses.
Bottom Line
Net operating income is essential in evaluating and valuing investment property. It helps real estate investors and lenders decide whether the property is worth investing in. It gives good insight into a property’s ability to generate cash flow as well as its overall value. The net operating income formula is the potential rental income minus vacancies plus other income minus operating expenses. If you want to calculate your NOI easily, use our free NOI calculator.