Definition
The Overall Rate of Return (OAR) represents the percentage relationship between a property’s Net Operating Income (NOI) and its purchase price, assisting investors in gauging the profitability and efficiency of real estate investments. Essentially, it evaluates how effectively a property can generate income relative to its cost.
Key Features
- Net Operating Income (NOI): The income generated from the property after deducting all operating expenses, except mortgage payments and taxes.
- Purchase Price: The total cost incurred to acquire the property.
Examples
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Example 1:
- Purchase Price: $1,000,000
- Net Operating Income: $100,000
- OAR Calculation: \( \frac{$100,000}{$1,000,000} = 0.10 \) or 10%
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Example 2:
- Purchase Price: $500,000
- Net Operating Income: $50,000
- OAR Calculation: \( \frac{$50,000}{$500,000} = 0.10 \) or 10%
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Example 3:
- Purchase Price: $750,000
- Net Operating Income: $60,000
- OAR Calculation: \( \frac{$60,000}{$750,000} = 0.08 \) or 8%
Frequently Asked Questions (FAQs)
What is the difference between OAR and Cap Rate?
Both OAR and Cap Rate are used to assess the profitability of a property, but while Cap Rate focuses strictly on the NOI divided by the current market value, OAR can consider the property’s purchase price.
Is a higher or lower OAR better?
A higher OAR generally indicates a more profitable investment, as it shows a higher return relative to the purchase price.
Can OAR change over time?
Yes, OAR can change as the NOI or the property value changes over time.
How is OAR useful for real estate investors?
OAR helps investors compare different properties and assess their income potential relative to purchase costs, aiding in investment decision making.
Are operating expenses included in the OAR calculation?
Yes, operating expenses are deducted from the income to arrive at the Net Operating Income, which is then used in the OAR calculation.
Capitalization Rate (Cap Rate)
The rate of return on a real estate investment property based on the income that the property is expected to generate.
Net Operating Income (NOI)
The revenue generated from a property after subtracting all reasonably necessary operating expenses.
Return on Investment (ROI)
A measure used to evaluate the efficiency or profitability of an investment or to compare the efficiency of several different investments.
Gross Rent Multiplier (GRM)
A rough measure of the value of an investment property that is obtained by dividing the property’s sale price by its gross rental income.
Online Resources
References
- Brueggeman, W.B., & Fisher, J.D. (2011). Real Estate Finance and Investments. McGraw-Hill.
- Linneman, P. (2018). Real Estate Finance and Investments: Risks and Opportunities. Linneman Associates.
Suggested Books for Further Studies
- Geltner, D., & Miller, N.G. (2017). Commercial Real Estate Analysis and Investments. South-Western Educational Publishing.
- Brown, J.T. (2008). Private Real Estate Investment: Data Analysis and Decision Making. Academic Press.
- Fitzgerald, T. (2011). Investing in Apartment Buildings: Create a Reliable Stream of Income and Build Long-Term Wealth. Wiley.
Real Estate Basics: Overall Rate of Return (OAR) Fundamentals Quiz
### How is the Overall Rate of Return (OAR) calculated?
- [x] Net Operating Income (NOI) divided by the property's purchase price.
- [ ] Mortgage payments divided by the property's market value.
- [ ] Total revenue divided by the purchase price.
- [ ] Property taxes divided by the NOI.
> **Explanation:** The Overall Rate of Return (OAR) is calculated by dividing the Net Operating Income (NOI) by the purchase price of the property.
### What is indicated by a higher OAR?
- [x] Greater profitability of the investment.
- [ ] Higher operating expenses.
- [ ] Lower net operating income.
- [ ] Younger property age.
> **Explanation:** A higher OAR indicates greater profitability relative to the property's purchase price, meaning the property generates more income in comparison to the acquisition cost.
### Which component is deducted from total revenue to calculate NOI?
- [ ] Mortgage payments
- [x] Operating expenses
- [ ] Purchase price
- [ ] Down payment
> **Explanation:** Operating expenses are deducted from the total revenue to determine the Net Operating Income (NOI), which is then used in the OAR calculation.
### Can OAR change over time?
- [x] Yes
- [ ] No
- [ ] Only if the property is sold
- [ ] Only if the mortgage changes
> **Explanation:** OAR can change over time as the Net Operating Income or the property value changes, influencing the overall rate of return.
### How does OAR assist real estate investors?
- [ ] By determining tax liabilities.
- [x] By comparing the profitability of different properties.
- [ ] By setting rental prices.
- [ ] By measuring property depreciation.
> **Explanation:** OAR helps investors compare different properties and assess their income potential relative to purchase costs, aiding in investment decision making.
### What makes OAR different from Cap Rate?
- [ ] OAR is only used for personal properties.
- [ ] Cap Rate includes market value, while OAR includes purchase price.
- [ ] OAR incorporates interest rates.
- [x] OAR considers purchase price, Cap Rate considers market value.
> **Explanation:** While Cap Rate typically considers the current market value of the property, OAR focuses on the purchase price.
### Why is OAR important for investment properties?
- [x] It measures income relative to purchase costs.
- [ ] It calculates mortgage rates.
- [ ] It logs annual operating expenses.
- [ ] It tracks capital gains.
> **Explanation:** OAR measures how effectively a property can generate income relative to its purchase cost, making it crucial for evaluating investment properties.
### What effect do increasing operating expenses have on OAR?
- [x] OAR decreases
- [ ] OAR increases
- [ ] OAR remains the same
- [ ] OAR is unaffected by operating expenses
> **Explanation:** Increasing operating expenses reduce the Net Operating Income (NOI), which in turn lowers the Overall Rate of Return (OAR).
### If a property has a NOI of $60,000 and a purchase price of $750,000, what is the OAR?
- [ ] 10%
- [ ] 15%
- [x] 8%
- [ ] 12%
> **Explanation:** The OAR can be calculated as $60,000 (NOI) divided by $750,000 (purchase price), equating to 0.08 or 8%.
### What is not included in the OAR calculation?
- [x] Mortgage payments
- [ ] Net Operating Income (NOI)
- [ ] Purchase price
- [ ] Operating expenses
> **Explanation:** Mortgage payments are not included in the OAR calculation as it is based strictly on Net Operating Income (NOI) and the purchase price.
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