Many real estate developers and investors use a simple formula to calculate net income when evaluating the viability of an investment property. And there’s nothing wrong with that formula.

Example: Let’s say you are going to purchase a single-family home for $250,000 with the intention of making it a rental property. The monthly costs to maintain the property are $800 (principal, interest, taxes, insurance, and maintenance). The property rents for $1,500. This leaves you with a net income of $700 ($1,500 – $800).

But my friend and mentor PS taught me another way to analyze a real estate investment. The best part of his formula is that it can open up your eyes to possibilities you never even considered.

PS made two fortunes in real estate. He made his first fortune the way many others did – by acquiring homes, medical office buildings, strip malls, and apartment buildings at deep discounts and then selling them for a profit. He made his second fortune in a more unusual real estate market: self-storage.

Now many investors discount offbeat real estate investments like self-storage. But when you apply PS’s formula, you can see how much money you can stand to make from them.

His formula figures out the actual revenue per square foot of an investment property. It doesn’t sound particularly special. But when he showed me how to apply it to a variety of real estate investments, I was shocked when I saw the numbers.

The Actual-Revenue-Per-Square-Foot Formula is calculated as follows:

(A) The total revenue of a real estate investment divided by (B) the total square footage of the investment equals (C) the actual revenue per square foot that is generated.

For example, a typical 1,500-square-foot single-family home in Chicago, IL generates $2,000 per month in rental revenue.

Doesn’t sound too shabby. But once you apply PS’s formula, you find that you’re making only $1.33 per square foot. ($2,000 divided by 1,500 square feet).

A typical 10-unit medical/professional office building in Cambridge, MA rents for $1,200 per unit (725 square feet each). Ten office units x $1,200 per unit equals $12,000 per month in rental revenue. $12,000 divided by 7,250 square feet (10 units x 725 sq ft) = $1.65 actual revenue per square foot.

Of course, this example assumes 100 percent occupancy, which is rarely the case. Lower occupancy would reduce the actual revenue per square foot. Still, you get the idea.

Let’s do some more calculations using the Actual-Revenue-Per-Square-Foot Formula:

Strip Mall (10 units)

$15,000 in total rental revenues per month. $15,000 divided by 12,500 total square feet = $1.20 actual revenue per square foot.

Apartment Building (8 units)

$7,800 in total rental revenues per month. $7,800 divided by 6,600 total square feet = $1.18 actual revenue per square foot.

Duplex (2 rental units)

$2,500 in total rental revenues per month. $2,500 divided by 1,900 total square feet = $1.31 actual revenue per square foot.

Marina (35 boat slips)

$22,750 in total boat slip rental revenues per month. $22,750 divided by 19,000 total square feet (the entire property) = $1.20 actual revenue per square foot.

Vacation Home

$2,500 in total rental revenues per month. $2,500 per month divided by 2,100 total square feet = $1.19 actual revenue per square foot.

Multi-Use Building (4 residential apartments/ 3 retail spaces)

$9,500 in total rental revenues per month. $9,500 per month divided by 6,500 total square feet = $1.46 actual revenue per square foot.

Mobile Home Park (45 spaces)

$32,625 in total space rental revenues per month. $32,625 divided by 87,120 total square feet (the entire property) = $.38 actual revenue per square foot.

As you can see, the Actual-Revenue-Per-Square-Foot Formula paints an interesting picture for just about any real estate investment.

Depending on the property, there could be variables that will affect the formula – like occupancy rates and revenues in addition to rentals that the property might bring in. For example, in my Marina and Mobile Home Park examples, there could be additional revenues from selling supplies, gas, and so on.

But, generally speaking, the Actual-Revenue-Per-Square-Foot Formula will tell you how much money you are receiving per square foot. And that will help you maximize the money-making potential of any real estate investment.

As I said earlier, this formula can also help you take a fresh look at some types of real estate that you might not have considered before. For instance, let’s look at private mailbox rental services. Pak Mail and The UPS Store are two of the most popular names here.

A typical Pak Mail location has about 650 total square feet of space and about 175 private mailbox units measuring 6" wide by 12" deep (about half a square foot). The average monthly rental fee for one of those mailboxes is about $25. Here’s the calculation:

$4,375 in total mailbox rental revenues per month (175 units x $25 each) divided by 650 square feet = $6.73 actual revenue per square foot! Far more profitable than any of my other examples. And this doesn’t even include revenue from packing supplies and other products that these stores sell.

Of course, you have to consider more than just actual revenue per square foot. On a financial spreadsheet, you would want to figure in not only additional revenues that a property might bring in, but also such things as operating expenses, property taxes, maintenance, and payroll (including employee benefits). And in the case of mailbox rental services, you have to consider the fact that these places are franchise operations. Maybe not the kind of investment you want to be involved in.

An unconventional real estate investment that I like better than mailbox rental services is self-storage. Not only are operating costs practically nil, but you don’t have to deal with tenants or customers. Plus, the typical 225-unit self-storage operation comes out ahead of many conventional real estate investments in terms of revenue per square foot. Here’s the math:

$33,750 in total rental revenues per month (225 units x an average of $150 per unit). $33,750 divided by 23,500 total square feet = $1.44 actual revenue per square foot.

Test the Average-Cost-Per-Square-Foot Formula on any real estate investment you’re considering – especially if you’re trying to decide between two likely opportunities. It will help you decide which one is the better candidate.

It can also help you make sense out of possibilities for increasing the actual revenue per square foot of properties you already own or are thinking of buying. For example – if zoning ordinances allow it – you might be able to add self-storage units to an office building, multi-use building, or strip mall.

[Ed. Note: Marc Charles, "The King of Business Opportunities," has launched more than 40 profitable businesses in the last 25 years. To learn more about how Marc is tapping into the multibillion-dollar self-storage industry, click here.

For more wealth-building strategies - including investing advice, entrepreneurship opportunities, and real estate investing techniques - check out ETR's "Profits in Paradise " Wealth Building Summit this April. For more information, click here.]

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This entry was posted on Tuesday, March 4th, 2008 at 5:00 pm and is filed under Real Estate Investing, Wealthy .