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Break Even Ratio

By Juan Cabrera, MBA realbench.net

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The Break Even Ratio is an indicator used by lenders when underwriting real estate investment properties, its purpose is to estimate how vulnerable a real estate investment property is to defaulting on its debt should rental income decline.

The lower the Break Even Ratio the better for the real estate investment property; the Break Even Ratio typically ranges between 70% and 100%. Most lenders look for a Break Even Ratio of 85% or less.

How to calculate the Break Even Ratio?

(Debt Service + Operating Expenses)

Break Even Ratio = --------------------------------------

Gross Operating Income

Example:

Monthly Rent	: $1,800
Vacancy Rate	: 3%
Monthly Mortgage Payment	: $1,200
Total Annual Expenses	: $3,000

STEP 1: Calculate Gross Annual Income

Gross Annual Income = Monthly Rent * 12
Gross Annual Income = $1,800 * 12
Gross Annual Income = $21,600

STEP 2: Calculate Annual Mortgage Payments

Annual Mortgage Payments =
Mortgage Payment * 12

Annual Mortgage Payments = $1,200 * 12
Annual Mortgage Payments = $14,400

STEP 3:Calculate Vacancy and Credit Loss

Vacancy and Credit Loss =
(Gross Annual Income * Vacancy Rate)/100

Vacancy and Credit Loss =
($21,600 * 3%)/100

Vacancy and Credit Loss =
$648

STEP 4:Calculate Gross Operating Income

Gross Operating Income =
Gross Annual Income - Vacancy_Credit Loss

Gross Operating Income =
$21,600 - $648

Gross Operating Income =
$20,952

STEP 5: Apply Formula

	(Debt Service + Operating Expenses)
Break Even Ratio	= --------------------------------------
	Gross Operating Income

	($14,400 + $3,000)
Break Even Ratio	= --------------------------------------
	$20,952

Break Even Ratio = 83.05%

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Last Updated May 28, 2010