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Real Estate Investing

Break Even Ratio, Explained



There are a lot of ratios to look at when investing in real estate, and it can get confusing. One of the lesser used but still important ratios is the break-even ratio.

The Break Even Ratio answers the question:

At what occupancy rate am I breaking even?

Good question to know the answer to, right?

Additionally, it allows lenders and other investors to assess the rental property for its ability to meet its operating expenses, debt service, and provide a level of profit.

Break Even Ratio Formula

To calculate the break even ratio, simply take the debt service + operating expenses – any reserves and divide by the gross operating income.

Break Even Ratio Example

Let’s say a given property has an annual debt service of $15,000 and it’s annual operating expenses are $12,000. The total yearly expenses for this property amounts to $27,000.

Now, let’s say this property has a gross income of $33,000 (not to be confused with the net operating income).

Total Expenses / Gross Income = Break Even Ratio

$27,000 / $33,000 = 81.8%

So, you need roughly 82% occupancy to break even and cover your expenses.

Break Even Ratio vs Debt Service Coverage Ratio

The DSCR and BER are clearly related. As you might remember, the debt service coverage ratio is the NOI / Debt service. It is the relationship between the NOI and Debt Service.

The break-even ratio is the relationship between all costs and income.

So, these are very closely related but answer slightly different questions.

The DSCR lets a lender know the borrower’s ability to pay the debt service. So, a DSCR of 1.25 means the borrower net income is 25% more than all of the operating costs (including debt service). They could lose 25% of their NOI and still cover the debt service.

The break even ratio is slightly different. It tells you how much of your gross income you can lose in order to break even.

So, the debt coverage ratio compares net income to the mortgage. Break even ratio compares gross income to total expenses.

When To Use Break Even Ratio

The break even ratio is important for both investors and lenders. It’s used to know what occupancy level you require in order to still cover your bills.

For example, if your break even ratio is 92%, an investor or lender may feel this deal is shaky because of the high occupancy required to keep the building afloat. It’s really common for occupancy levels to drop below 90%, especially during a recession.

On the other hand, if the break-even ratio is 75%, an investor or lender would be far more confident in the deal knowing that during the worst case scenario of a 25% vacancy rate, the property could still cover all of its expenses and obligations.

Additionally, investors may analyze a deal by looking at the break-even occupancy rate both at acquisition and after the building is remodeled and stabilized.

For example, if we are buying a deal with a heavy rehab component, we might expect it is currently underwater or barely breaking even. So, a break even occupancy of 95% or even over 100% would be expected.

We could project out one or two years and look at what the stabilized property would look like, and determine the break even occupancy at that point. Let’s say that in year two, the break even ratio is a much healthier 82%, so we might choose to take this deal.

On the other hand, if we did all this remodeling and work and the break even ratio was 90%, we might reconsider investing in the deal.

Break Even Ratio Rule of Thumb

As a general rule of thumb, lenders will look for a break even ratio of 85% or less. Just like everything else in real estate, this number fluctuates and depends on the lender and property, but a ratio under 85% is good.

This means the total rent collected can drop by 15% and you still can cover all of the bills. That’s pretty good for income producing property.

Analyzing Real Estate Deals

When analyzing your rental property deals, there are a number of metrics you’ll want to use to determine if it’s a good deal.

First, you want to know what it will be worth when any upgrades or rehab is completed. This is called the After Repair Value. You calculate this by doing a comparative market analysis (if it’s a smaller deal) or by using capitalization rates (if it’s a larger deal).

The next thing you want to look at is the average cash on cash return as well as the overall return on investment over the timeframe of the deal. You’ll want to look at the in-place cash on cash return day 1 and compare it to the cash on cash return once the work is complete and rents are pushed.

You do this because you want to walk into a cash flowing property day one, then add value. It’s a lot harder to buy something that is cash flow negative and turn it around.

This is where you’ll look at the break even ratio to see how the deal performs both day 1 and after it’s stabilized.

Now, you’ll want to look at overall financing and how that affects your returns. This is where the debt coverage ratio comes into play. If the DSCR is too low, you’ll get less loan proceeds which means higher cash out of pocket and lower cash on cash returns.

With all of this information, you can make an informed decision to buy or not to buy.

This article originally appeared on IdealREI.  Follow them on Facebook, Instagram and Twitter.


Featured image: Image by Steve Buissinne from Pixabay

Real Estate Investing

Here’s Why You Need To Use A Mortgage Broker When Buying Your Home



Would you like to build or buy a home today?

There are many factors that you should consider. You will note that earlier on, most people used to visit banks in order to get loans that could enable them build or buy a house of their dreams. This used to work well for some people.

However, others used to have a difficult time securing loans. This is because some banks used to charge higher interest rates. This normally discouraged these people. This is the reason why you should consider using a mortgage broker.

What are the advantages of working with this broker? These include:

1. Enable you to Save Money

Would you like to save more money when you are buying a home? You should consider using the services of a mortgage broker. You will realize that this broker can help you compare several home loans from dozens of lenders.

You will not be dealing with one lender only. The good news is that you will be dealing with different lenders. This can help you get a good deal in terms of interest rates and fees.

This can play a major role in helping you save more money.

2. Saves Time

The process of getting a home loan can be very tasking. You have to visit different lenders so that you can compare their interest rates. Sometimes, you might not have all this time. You might end up choosing a lender who charges you more interest.

If you want to save more time, you should consider using the services of this professional. The good news is that this professional will do most of the work for you.

This will include the following activities; liaising with conveyances, real-estate agents, lenders and even settlement agencies.

3. More Peace of Mind

Securing a good mortgage loan can be very hectic. Most people normally struggle to secure these loans successfully. This can make you not to enjoy some peace of mind.

However, the good news is that this professional can help you secure a good loan successfully. You can trust that he will go for the best option out there. This can help you have some peace of mind as you will be doing other activities either at home or at the workplace.

You will realize that this professional will stay in contact with you to check if you have the right mortgage from the right lender.

4. Little Chances of Refusal

There are people who normally apply for a mortgage loan and are denied this loan. This could be due to their credit score, among other factors. This can be detrimental. You are likely to get frustrated.

Some lenders are very strict. However, there are some who are lenient. This is because different lenders normally have different credit policies and restrictions regarding who they will lend to. This is the reason why you should choose this broker to help you out.

This broker will considerably reduce the chances of refusal because he has vast knowledge on lender policies. He will help you settle for a good deal. Thus, an increase the chances of you building or buying your dream home.

5. Professional Advice

You can trust that this professional will help you understand all the mortgage-related information. He or she will help you understand the numerous types of mortgage available out there.

You will note that each of the mortgage types normally has its own parameter and technicalities. This can actually be very confusing to the common man. This mortgage broker will help you sort out all this information and also explain the different types of deals available in the market.

The good news is that this expert will help you narrow down the information to finally choose the mortgage that suits your needs. Sometimes, it is difficult to understand all the legalities that are related to mortgages.

However, this professional will give you professional advice in this field. This can help you avoid certain pitfalls since you will be fully aware of everything that you must know.

6. More Convenient

We all like convenience. The good news is that the professional will work hand-in-hand with home loans and lenders every day of the week. You can trust that this professional will assure you that the entire process will go smoothly and successfully.

7. He Represents you

The good news is that the mortgage broker normally represents you. You can trust that he will work on your behalf and not on behalf of a particular bank.

He will work with different lenders to ensure that you get the best deal out there.

8. You do not have to Pay this Broker Directly

You will realize that you do not have to pay this broker directly for their services. In most cases, they are normally paid by the financial institutions that arranged your mortgage. This makes it ideal to work with this broker.

The mortgage broker normally works for you. He is independent and can help you navigate the often confusing world of mortgages. He or she will work on getting the best deal for you.

This is because dealing directly with the companies can be hard. Some of them might not have the best interest in mind. This is the reason why you should consider using the services of a mortgage broker.

In addition, he or she will help you save more time in the long run. You can carry on with your usual activities either at home or at work as the broker works for you.

You will even manage to save more money. Consider hiring the services of this broker, and you will not regret. The services of this broker are truly incredible.

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Real Estate Investing

5 Strategies To Close Your First Real Estate Deal



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