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How Loan Amortization Benefits Real Estate Investors

loan amortizationReal estate investors enjoy many benefits by owning real estate investment property generally including short and long term revenue streams, annual income tax deduction allowances, a monetary hedge against inflation, and the pride of ownership with being a landlord.

In this article, though, we’ll look at a somewhat more obscure benefit afforded real estate investors known as loan amortization because it might not have been considered by novices thinking about real estate investing.

What is Loan Amortization?

Loan amortization is the liquidation of a debt over time by an installment of payments over time. Here’s the idea.

Typically all real estate property financed consists of a loan payment comprised of both interest and principal. Therefore, each payment made by the owner satisfies the lender’s yield along with some amount of principal reduction to his or her mortgage balance.

As a result, each loan payment that includes both interest and principal chips away at the balance of the loan until finally (after so many years) the mortgage is completely satisfied, the debt is paid off in full, and the loan amount no longer exists.

You might have experienced this concept if you financed a home. That a thirty-year fully-amortized fixed rate mortgage would be reduce the principal to zero after three hundred and sixty payments and the home would be yours, debt-free without a lender to answer to.

Debt Service (total mortgage payment)
less Interest Paid (for the bank)
= Loan Amortization (your loan’s principal reduction)

Benefit to Real Estate Investors

Okay, but unlike your personal residence where you alone must make the principal payments to reduce the loan in usually monthly installments, as a real estate investor you gain a notable benefit.

For it is not you, but your tenants who make those monthly payments and pay down your mortgage. Think about it.

Each time one of your tenants makes a rent payment to occupy one of your rental properties they are essentially helping you to own the property outright.

In other words, your tenants are not only paying your bills, they are paying down your mortgage and in turn adding more equity you have in the real investment property.

Executive 10: Software Updated

ProAPOD has updated it’s Executive 10 real estate investing software solution. If you are a current Executive 10 customer, you can obtain this update by logging in to your account page. From the ProAPOD website click the Login link in the upper right-hand corner.

This ambitious software update has been in the making for the past four weeks. Here are some of the major improvements.

  1. The Assumptions report has been modified to include more analysis details about the property. For example, it provides specific information about all three loans (when applicable). The previous version only included details for the first loan. It also now includes an itemized list for Other Income and Miscellaneous operating expenses. In other words, all the entries you make on the Income and Expenses forms are now included. The previous version did not show these items. It also now includes the details for capital additions and funding (when applicable). The previous version did not show capital additions. The report has also been developed to be “smart”; that is, it will only show the data you include for the property so there is no wasted space on the report for items without data.
  2. The APOD has been modified in primarily two ways. The amount for “Replacement Reserves” has been relocated from the Operating Expenses and will show as a deduction from the Net Operating Income (when applicable). Since these reserves are not really an operating expense it seemed better suited to merely show it as a deduction from income. The APOD will also show non-funded first-year capital additions as a deduction from income. In other words, if you are planning capital additions in the first year for $25,000 and are going to borrow $15,000 to cover those additions, the APOD will show those details and deduct the non-funded amount (i.e.,$10,000) from the Net Operating Income. The APOD has also been developed to be “smart”; that is, it will automatically format to show only data that you include in the forms so there is no wasted space on the report for items without data.
  3. The Proforma form has been modified to make it easier to inflate income and expenses (when applicable) as well as adjust the vacancy rate (when applicable). Executive 10 has always enabled you to adjust income, expenses and vacancy rate up to three times for the Proforma Income Statement; this new form will just make it easier to understand and process.
  4. The Print process has been restructured to make it more seamless. This will be particularly noticeable when  printing a PDF. Rather than handling each report selection separately as before with PDF printing, in this update all your selections are handled as one unit. This makes the process faster, easier, and much more seamless. A Help file has also been added to the Print menu with instructions on how to create the PDF.
  5. Other modifications made to some of the forms and menus are not as significant but worth mentioning because they will enhance your experience when using the software.

It should also be noted that we also eliminated the dollar symbol option and calculator from the software. Neither provided a strong benefit and were deemed unnecessary extra “baggage” that the software would function better without.

You can preview some of the modified reports at Real Estate Investing Software Reports. Click the link “Full Analysis Sample” (opens as a PDF).

Although every effort has been made to insure that the software works correctly, please notify me immediately if you encounter an issue that needs to be fixed.

Understanding Gross Scheduled Income and Gross Operating Income

gross scheduled incomeIn any real estate analysis previewed you will typically see in such reports as an APOD or Proforma Income Statement an amount shown for both Gross Scheduled Income (GSI) and Gross Operating Income (GOI).

So what are these income values, how do they differ, and what impact do they have on the bottom line of the property you are evaluating?

Okay, let’s take a look.

Gross Scheduled Income

Gross scheduled income is considered as the gross income that would be collected from a rental property with all units 100% occupied and rented. That is, it is the amount of annual rental income that would be collected if the property experienced zero vacancy and credit loss. To make this happen, vacant units (if they exist) are included in the calculation at a fair market rent.

In other words, if you have a rental income property consisting of eighty units with two units vacant where the occupied units are currently rented for $740 and you feel the market rent should be $750. You would compute the GSI by showing the occupied units at their current rent of $740 and the vacant units at $750.

78 units occupied @ 740 = 692,640
+ 2 vacant units @ 750 = 18,000
GSI = 710,640

Naturally no experienced real estate investor (hope as they might) ever expects to have all the units occupied all of the time; nor do the lenders.  Therefore it is prudent to subtract a reasonable amount for vacancy and credit loss from the gross scheduled income to arrive at what is called an effective gross income (or EGI).

Effective Gross Income

Here’s how it works. Let’s assume a gross scheduled income of $710,640 and a vacancy and credit loss of 5.00%. The effective gross income is computed this way.

$710,640
– 3,552 (5% of 710,640)
EGI = 707,087

Gross Operating Income

Okay, now we’re ready to compute the gross operating income. This final step adds the revenues collected from other sources of income generated by the property (i.e., coin operated washers and dryers, garages, storage units) to the effective gross income. To illustrate this we’ll assume that all other income annually generated by the property totals $18,000.

$707,087
+ 18,000
GOI = 725,087

Why Do Investors Care?

Fair enough, so why do real estate investors care about these numbers in their real estate analysis?

Foremost, because gross scheduled income and gross operating income each refer to the annual revenue generated by an income property (albeit differently), and as such each expresses something about a property’s financial performance. GSI reveals the total income potential that can be collected annually from rents, while GOI (which evolves from GSI) discloses the actual income an investor can expect to collect to service the property’s operating expenses and debt service.

Here’s to your real estate investing success.