An Easy Formula to Determine If Your Spouse Deserves Alimony or Support: The Debt-to-Asset Ratio

DebtIn considering a spouse’s entitlement to support or an award of counsel fees, courts generally examine a number of factors, such as the richer spouse’s ability to pay, the dependent spouse’s financial need, the parties’ access to other financial resources and liquid assets, and whether they each exercised good faith or bad faith in the proceedings. A helpful way to interpret several of these factors is to examine the “Debt-to-Asset Ratio.”

 The debt-to-asset ratio determines how much of each party’s assets are financed or encumbered by debt. As such, it provides a measure of the dependent spouse’s need for support compared to her access to valuable assets.

The data necessary to construct this ratio is readily available in the financial disclosures that parties are required to make as a part of the pretrial discovery process in a divorce action. So, for example, a spouse’s total debt, or her total assets, can be gleaned from the Statement of Net Worth used in New York proceedings, the Affidavit of Financial Information used in Arizona, the Case Information Statement required in New Jersey divorces, or the Financial Affidavit required in Florida and many other states.

There are just three simple steps: First, calculate a spouse’s total debt. Then, calculate total assets. Then, divide total debt by total assets.

AssetsFor example, assume that Wife’s total liabilities are $300,000, and her total assets are $500,000. The debt-to-asset ratio is 0.60 ($300,000 divided by $500,000). This means that for every 60 cents in total debt, the Wife has total assets of $1. If Husband has a ratio lower than 0.60, then his financial position is better.

The objective is to have a lower number because it is better not to owe too much money. Thus, in arguing alimony and child support motions, it is useful to note which party has the lower (better) debt-to-asset ratio. If Wife has a ratio of .60 and Husband has a ratio of .20, one might argue that the Husband has a stronger (more asset-rich) financial foundation and has a clear ability to pay more support. In a jurisdiction in which the court will attempt to equalize the financial positions of the parties, one might argue that the Husband should pay enough money to the Wife to equalize both of their ratios at .40 – effectively giving them a comparable debt-to-assets balance.

Consider another scenario. On his financial disclosures, an unemployed Husband reports total debt at $219,650. Having been dispossessed of his only real estate in a foreclosure action, the Husband counts $132,000 in personal assets. His debt-to-asset ratio is disquieting: Debt to Asset 1

The ratio indicates that for every $1.66 in debt, the Husband has only $1 in assets. His top-heavy or upside-down condition may very well help him to argue for alimony, spousal support, maintenance, or an award of counsel fees from a more financially secure Wife.

 The ratio may also assist the Husband in arguing for a reassignment of assets as part of the divorce proceedings. In the scenario above, the Husband has only $1 worth of assets to cover every $1.66 of debt. If the Husband were to liquidate his assets – essentially selling everything to pay off his debt – he would be able to cover only about 60% of his obligations. Debt to Asset 2In this regard, Husband could argue that he should receive an award of additional assets. In a mathematically perfect world, for example, Husband could assert that an additional $87,650 in assets would bring his debt-to-asset ratio to 1:1; that is, exactly $1 of debt for every $1 of assets.

Debt to Asset 3

 In a more likely scenario, however, there could be insufficient assets to bring each party down to a ratio of 1, or there may be enough assets to lower each party’s ratio to a comparable number below 1.

Suppose that, at the time of their separation, Husband had debt of $219,650 and Wife had debt of $111,000. Husband had assets of $132,000 and Wife had assets of $121,000. In the divorce which ensues, the Husband contends that he is the dependent spouse and demands a financial and/or property distribution from his Wife. The Wife, in defense, points out that Husband walked away with $11,000 more in assets than she has. Let’s compare each party’s debt-to-asset ratio:

 Debt to Asset 4

Here, it is evident that the Wife is not nearly as financially burdened as Husband. In the event of full liquidation, the Wife could cover her indebtedness because she has only 91 cents in debt for every dollar in assets. The disparity in the two ratios offers a negotiating opportunity to the Husband’s counsel. While it may not be appropriate to settle a divorce exclusively on the basis of the disparity in these ratios, the information produced by these ratios provides a useful bargaining tool. Consider two approaches:

 Approach #1: Reassigning Debt

The Husband’s attorney could seek a payment of alimony or spousal support from Wife that would assist Husband in reducing his debt more quickly. Or, Husband’s attorney could argue that a particular debt should be reassigned from Husband to Wife in order to equalize (or nearly equalize) their debt-to-asset ratios. For example, let’s say that Husband had been assuming responsibility for a $44,650 bank loan, among his other debts. Husband’s attorney could argue that this particular loan (which was marital in nature) should be shifted to Wife in order to apportion the parties’ debt commitments more equitably. If Wife agreed to assume responsibility for the $44,650 bank loan, the respective debt-to-asset ratios would be adjusted as follows:

 Debt to Asset 5

By reassigning the bank loan to Wife, Husband has lowered his debt-to-asset ratio to 1.32 while Wife has raised her ratio to 1.28. The ratios are now quite close, and with other minor adjustments between the parties, an equitable resolution of the divorce can be achieved.

Approach #2: Reassigning Assets

The second approach to equalizing or approximately balancing the ratios is to reassign assets from one spouse to the other. Using the original ratios for Husband and Wife provided above, let’s assume that there are no reassignable debts. However, Wife’s assets of $121,000 consist of a number of investments, two of which can be safely transferred without any penalties, fees or tax consequences. The two investments are valued at $16,000 each, for a total of $32,000. By transferring these investment assets to Husband, the parties will achieve somewhat more comparable debt-to-asset ratios:

 Debt to Asset 6

While the ratios are not identical, the disparity between the parties has been significantly reduced. With other financial or equitable adjustments between the parties, the prospect of a fair settlement now seems much more achievable.

The debt-to-asset ratio, like the debt-to-equity ratio, is a common calculation on the corporate frontier. It is not, however, limited to business analysts and corporate lawyers. The debt-to-asset ratio provides a practical snapshot of a separated spouse’s financial condition. A ratio under 1 means that a majority of that spouse’s assets are financed through equity; a ratio greater than 1 means they are financed more by debt. The higher the ratio above 1, the more debt-leveraged the spouse. Knowing this information can help a dependent spouse qualify for spousal support or for a redistribution of assets. It may also assist an obligor spouse in arguing that he is already too leveraged by debt to pay support or to relinquish any unencumbered property.

Like all ratios, however, the debt-to-asset comparison should not be considered in isolation. Rather, it should be used as one of several tools aimed at structuring a reasonable settlement, or as one of several devices to persuade a judge to enter a well-reasoned judgment.


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I Can’t Pay My Bills! Which Spouse Is REALLY In the Better Financial Position?

shutterstock_355978433Husband and Wife have split up. Now they’re living in two households. And each of them is complaining that they don’t have enough money to pay their bills. Molly, the wife, wants alimony because she cannot pay her rent or her credit card bills in order to sustain her marital lifestyle. Henry, her husband, says he has his own debts to worry about. He says he cannot pay Molly’s request for alimony and sustain his own lifestyle at an equivalent level at the same time.

How do we determine which party’s debt obligations are greater in the context of their earnings?  One approach is to look at the ratio of take-home pay to debt-service charges. This ratio determines how well one’s net wages cover her monthly payments of principal and interest on credit cards and loan accounts.

Debt service can be calculated by determining the sum of all payments due on loans, credit accounts, and other debts for a fixed period of time. In fact, some financial statements required by divorce courts provide a line item for debt service under the listing of the party’s personal expenses. In other jurisdictions, it may be necessary to ascertain the debt service from several line items on the financial statement or other disclosure document.

Let’s assume that Molly has a monthly debt service of $2,099, calculated as follows:

Debt Service Box 1

If Molly nets $6,500 in monthly wages, with a total debt service of $2,099, then her take-home pay-to-debt service ratio would look something like this:

Debt Service Formula 1

In other words, Molly would have a ratio of 3.09. This means that she has $3.09 in take-home pay for every $1 dedicated to paying credit card bills and loan accounts. Not bad. In fact, a ratio above 3 is considered favorable; under 2 is considered risky. For Molly and her attorney, the goal is to obtain a higher ratio.

Of course, the ratio can be utilized and compared in a number of different ways. If, for example, Molly has obtained a wage garnishment order that withdraws alimony and child support from Henry’s paycheck each week, then Henry’s take-home pay will be correspondingly lower. If the amount of the support payment is too high, and if Henry’s ratio drops considerably lower that Molly’s, Henry may choose to challenge the support orders or other aspects of the divorce case.

So, for example, assume that Molly has a take-home pay-to-debt service ratio of 3.09 and Henry has a ratio of 6.4. As a measure of liquidity, this comparison would suggest that Henry is in a much stronger position. This could be attributable to Henry’s higher paycheck alone. Or perhaps Henry has fewer credit card bills. In matrimonial negotiations, such a disparity in ratios presents an opportunity for Molly’s attorney. A significant disparity between take-home pay-to-debt service ratios can be addressed from several approaches, one of which considers the numerator (take-home pay), and one which considers the denominator (debt service).

shutterstock_68272453Approach #1: Modifying Support

By requiring Henry to pay more spousal support or child support, Molly can essentially reduce Henry’s take-home pay, and in so doing reduce his take-home pay-to-debt service ratio. If Molly were to receive an additional infusion of net cash (after payment of any taxes on alimony), her ratio would correspondingly increase. For example, an additional monthly payment of $1,000, effectively increasing Molly’s take-home pay to $7,500, would boost her ratio to 3.57.

Suppose Henry had a significantly lower take-home pay-to-debt service ratio of 1.2. This means that his paycheck would provide only $1.20 to cover every dollar of debt repayment he was obligated to make – a very small cushion. Henry’s attorney would thus agree that Henry’s support obligations should be reduced because he is in a far less liquid condition than Molly. By lowering Henry’s support obligations, Henry’s take-home pay would now increase, and his ratio would correspondingly grow.

Approach #2: Reducing Debt Service

If take-home pay cannot be adjusted, then the ratio can be modified by reassigning debt between the spouses. If Molly then reduces her debt service, even without altering her take-home pay, she will enjoy a higher ratio. So, for example, if Molly’s attorney can persuade Henry’s attorney that Henry should assume responsibility for the CitiBank Visa and SteelBank Credit Lines, he will have shifted $355 in debt service to Henry. By reducing Molly’s  debt service by this amount, Molly’s new take-home pay-to-debt service ratio would be 3.72.

Debt Service Formula 2

Now, Molly has $3.72 to cover every $1 of debt.

The opposite scenario is also true. If Henry had a lower ratio of 1.2, as suggested under Approach #1 above, and if he was unable to persuade his wife or a judge to lower his support obligations, he might wish to turn his attention toward reassigning his debt service. By transferring one or more of his credit obligations or monthly bills to Molly, Henry would reduce his debt service, while increasing his ratio, and Molly would increase her debt service, while reducing her ratio.





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I’ve Been Rear-Ended! How Fast Was That Other Car Going? Here’s the Formula.

Car Crash 1So you’re sitting there in your car at the stop sign, obeying the law, and then….whack!  You’ve been rear-ended by another driver who was texting his friend about tonight’s important gathering at the local pub. Upon impact, your car careens across the intersection.

How fast was the other driver going?  Here’s how to figure that out.

You’ll need four pieces of information for this formula: (1) the weight of other driver’s vehicle which we’ll call W1, (2) the weight of your vehicle which we’ll call W2, (3) the velocity of the other driver’s vehicle after the crash or post-impact, which we’ll call Vp1, and (4) the velocity of your vehicle as it careened through the intersection post-impact which we’ll call Vp2. In our formula, we will refer to the impact speed or velocity of the other driver as V1. The formula is:

Rear Ender Formula

So let’s try a hypothetical case. Assume that you were driving a Chevrolet Malibu weighing 3,300 pounds at the time of the accident. You were rear-ended by a Ford Explorer weighing 4,900 pounds.  Assume also that, following impact, your vehicle (which had initially been stopped at a stop sign) moved across the intersection at the speed of 20 miles per hour. The Ford Explorer, post impact, moved across the intersection in the opposite direction at 35 miles per hour. 

Rear Ender Formula 2

Rear Ender Formula 3

In other words, the driver of the Ford Explorer was traveling at about 48.5 miles per hour at the moment of impact. If the accident occurred in a 35 mile per hour speed zone, this would be a significant piece of information, ascertained through a relatively simply formula. 

Obtaining vehicle weights is very easy. Such information is published online and in owner’s manuals as part of the listed specifications (“specs”) for the vehicles. As for determining the post-impact velocities of the vehicles, such information can be gathered in a number of different ways. There are forensic techniques, for example, such as skid marks, debris evidence, and physical damage measured against other timed events. There are witness observations. There may be physical damage to a guard rail, tree, building or other structure where a vehicle actually comes to rest, and the damage itself may reflect speed.

In a personal injury lawsuit, a driver may also admit to a particular post-impact speed as part of a pre-trial discovery response (for example, in responses to an interrogatory or deposition question or a request for admissions). And there are other formulas for ascertaining post-impact speed to be discussed in a future blog.   


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Alimony: How Much Can I Pay Now To Buy My Way Out of It Forever?

alimony ballOh no! The ugly “A” word — Alimony.  It may be tax-deductible to the party paying it, and taxable to the party receiving it, but it’s controversial nevertheless. The spouse who is obligated to pay alimony often objects to the process of writing weekly or monthly checks to his ex-spouse, especially if his own financial situation is not improving as time marches on. 

What if he could pluck down a certain amount of money today and buy her off? How much money today — paid all at once — would be enough to buy out a long-term alimony award? Let’s take a look.

Discounted Cash Flows

Assume Husband will make a deal by which a certain amount of his own money can be invested at 5% to generate a cash flow to his wife over the next five years. The parties negotiate long and hard. Wife proposes that she receive a cash flow of $100,000 in year 1, $300,000 in years 2, 3 and 4, and $100,000 in year 5. She demands that Husband invest one million dollars to fund the cash flows which she seeks. Husband tells his lawyer that he has no objection to Wife’s yearly cash flows, but seeks the lawyer’s advice as to whether a $1 million investment is appropriate. How far will $1 million stretch, at 5% interest, over five years, given the precise payout schedule Wife wants?

The inquiry is answered by the discounted cash flow procedure.

Step 1:  Add the interest rate to 1. Thus, 1 + 05 = 1.05

Step 2:  Use 1.05 for year 1. For year 2, use 1.05 to the second power. For year 3, it’s 1.05 to the third power…and so forth.

Step 3: Divide the amount to be paid in each year by the finalized interest rate. Thus, in year 1, we divide $100,000 by 1.05. In year 2, we divide $300,000 by 1.1025 (which is 1.05 to the second power). In year 3, we divide $300,000 by 1.1576 (which is 1.05 to the third power)…and so forth.

Step 4:  Add each year’s totals together.

Follow the complete formula below::

Alimony Snip 1


So, the net present value of the cash flows to the Wife would be $951,666.

In other words, Husband will need to invest only $951,666 to meet Wife’s five-year cash flow proposal, not $1 million. Demonstrating how the discounted cash flow procedure works could thus save Husband over $48,000.

Permanent Alimony (Perpetuities)

Husband doesn’t want to write alimony checks, but the parties agree that Wife qualifies for permanent alimony. The parties agree that Wife should receive $100,000 per year for life. If Husband has a significant estate and is able to invest a lump sum at 10%, how much should he invest to generate cash flows of $100,000 per year for Wife? Answer: $1 million. The formula is simple: Divide the Wife’s annual amount by the interest rate: $100,000 divided by .10 = $1 million.

The formula is known as the present value of a perpetuity because it continues in perpetuity. Thus, in structuring a deal, the parties must address the eventual pay-out of the corpus ($1 million) upon the payee’s death (or upon her remarriage, as the case may be). Unlike alimony, the payment of a perpetuity to generate annual lifelong cash flows to the Wife will not automatically terminate upon the death of the Husband.

What if Husband agreed to pay Wife $50,000 per year for life? Assume that a 6% interest rate applies. How much should Husband invest now to guarantee annual payments of $50,000.

$50,000/0.06 = 833,333.33

In this scenario, Husband should invest $833,333.33, assuming a stable 6% interest rate.

Alimony CoupleLimited Term Alimony (Present Value of an Annuity)

Assume that Wife is seeking $2,000 per month in alimony, and Husband is not conceptually opposed to the amount. Husband does not want to write the monthly checks. Husband consults his attorney about converting one his assets to an account or an investment to fund the monthly alimony payments. The parties negotiate, and they agree that Wife would get $2,000 per month in limited duration alimony for a period of 10 years. How much must Husband deposit now to fund the payments for the 10-year term?

There are eight steps:

Step 1:  Annualize the alimony. In other words, $2,000 per month equals $24,000 per year.

Step 2:  Determine the available interest rate. Let’s assume 5%. Add the interest rate to 1, creating the multiplier of 1.05.

Step 3:  Raise 1.05 to the tenth power, because 10 is the number of years that the limited duration alimony will be paid. Thus, Step 3 Insert

Step 4: Multiply the interest rate (.05) by 1.63, which equals .08.

Step 5:  Divide 1 by .08, which equals 12.5.

Step 6:  Divide 1 by the interest rate (.05). Thus, 1 ÷ .05 = 20.

Step 7:  Subtract 12.5 (Step 5) from 20 (Step 6). Thus, 20 – 12.5 = 7.5.

Step 8:  Multiply  the annual alimony payment ($24,000) by 7.5. Hence, $24,000 x 7.5 = $180,000.

Conclusion: In order to fund a limited term of alimony of $2,000 per month for 10 years, Husband must set aside $180,000 today at 5% interest. This calculation is often known by financial experts as the present value of annuity. Here is the official formula:

Alimony Formula 1

where C equals the cash or alimony which the Wife will be receiving annually, r equals the interest rate, and t equals the number of years in the term. Let’s do the math:

Alimony Formula 2









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Damages for Interfering With Your Real Property Rights. What’s It Worth?

old house with windowsWhen you’ve suffered damages to y0ur real estate involving an income-producing property, it is sometimes difficult to determine exactly how much money you’ve lost. In fact, we often tend to under-estimate our losses by not considering how the timely payment of money goes to work for us. Today’s blog shows you some useful formulas for calculating the loss of income generated by an income-producing property — when somebody else is to blame.

Debt Service Coverage Ratio

The debt service coverage ratio (DSCR) answers the question: how much income is available to pay down debt after operating expenses have been paid. The formula explores the relationship between net operating income (NOI) and debt obligations. It actually produces a net income percentage, and the difference in that percentage from one point in time to another reflects a potential item of damages. The formula is NOI/Debt, where the debt consists of principal plus the interest, such as in the case of a mortgage payment.

For example, let’s say that Oscar has a rental property with an NOI of $50,000. He has mortgage payments (principal plus interest) totaling $39,800. Oscar’s debt service coverage ratio is 25.6%.


DSCR = $50,000/$39,800

DSCR = 1.256

[1.256 – 1 = 0.256]

If Oscar’s mortgage debt were as high as his NOI ($50,000), his income-to-debt ratio would be 1 (or effectively, 1 to 1), meaning that his rental property would generate only enough money in income to cover its debt. In the example above, however, Oscar’s DSCR is 1.256, meaning that he is generating 25.6% more in income than he needs to cover his debt (to pay his mortgage).

Let’s now assume that the contamination of a water system by an industrial polluter prompts civil litigation over the adverse effects suffered by Oscar’s rental properties. One way to explore the damages Oscar suffered is to examine the difference in debt service coverage both before and after the adverse events occurred.

After the water system contamination, Oscar’s NOI may have dropped to $40,000. His DSCR now looks like this:


DSCR = $40,000/$39,800

DSCR = 1.005

[1.005 – 1 = 0.005]

His revised DSCR is now just 0.5% — a significant drop from the 25.6% he enjoyed before the contamination occurred.

Or, let’s assume that Oscar’s NOI remains the same at $50,000, but that his special plumbing, piping, and water supply replacement costs rise significantly, raising his total recurring debt to $51,500. The DSCR ratio now produces a problematic result:


DSCR = $50,000/$51,500

DSCR = 0.970

[0.970 – 1 = 0.03]

Now, Oscar is not generating enough income to meet his debt. In fact, he is negative 3%, that is 3% short. His damages, based on the pre-contamination DSCR of 25.6%, are nearly 29% (representing the difference between a positive 25.6% and a negative -3%).

Another approach to DSCR formula is to account for the tax rate in calculating debt. In this variation, NOI is treated as earnings before interest and taxes. Debt is treated as principal plus interest, but the principal is divided by the inverse of the tax rate (that is, 1 minus tax rate). The revised formula is:

DSCR = Operating Income (Earnings before interest and taxes) divided by [(Principal/1-Tax Rate) + Interest]

We’ll assume that the operating income is $100,00, and that the interest due is $20,000. The principal of $50,000 is divided by 1 minus the tax rate, which we’ll say is 33% in this case.

DSCR = $100,000 / [($50,000/1-0.33) + $20,000]

DSCR = $100,000/$74,626.87 +$20,000

DSCR = $100,000/$94,626.87

DSCR = 1.056

[1.056 – 1 = 0.056].

The DSCR is therefore 5.6% at a 33% tax rate.

Return on Investment

The basic formula for return on investment (ROI) can also be explored to gauge damages in a real estate action. ROI, in its simplest form, is stated as the gains minus the costs, divided by the costs:

ROI = Gains – Costs / Costs

This could be stated as income minus costs divided by costs:

ROI = Income – Costs / Costs

It is essentially the difference between the before-and-after ROIs that provides a snapshot of our damages in a given case.

Example: A mudslide occurs on a residential tract causing significant structural damage, attributable to negligent engineering, design, and construction work. Before the mudslide, the subject property generated $2.4 million in income at a cost of $800,000. After the mudslide, it generates $1.9 million in income at a cost of $950,000. Using the simplified formula for ROI, we can compare before-and-after scenarios: 


ROI = Income – Costs/ Costs

ROI = $2,400,000 – $800,000/ $800,000

ROI = 2

2 x 100% = 200%

Therefore, before the mudslide, there was a 200% return on investment.


ROI = Income – Costs/ Costs

ROI = $1,900,000 – $950,000/ $950,000

ROI = 1

1 x 100% = 100%

Therefore, after the mudslide, there was a 100% return on investment.

Another variation of the simplified ROI is to divide net profit by assets. In this approach, costs are deducted from the numerator to produce a single net profit amount. If, for example, net profit was stated at $85,000, and assets were valued at $225,00, the formula would look like this:

ROI = $85,000/$225,000 = 0.3777

ROI is therefore approximately 38%. Again, a before-and-after analysis can provide a useful snapshot of the damages suffered in a given case.

Another way to characterize the ROI formula is to treat the numerator as the NOI, which is roughly the equivalent of income minus costs or net profit. In this variation, we divide the NOI by the total investment:

ROI = NOI/Total Investment

Assume that an investor wishes to purchase a large income-producing property and, under current market conditions, can make the purchase for a down payment of $100,000. The sellers, however, did not relinquish the premises on a timely basis, and because of the delay, the investor lost the advantage of a lower interest rate, costing him an additional $10,000. Moreover, the sellers fraudulently concealed a construction defect which the investor was forced to repair at a cost of $33,000. Altogether, the investor’s total investment equals $143,000.

If the investor’s NOI was $17,500, then his ROI would be roughly 12%, calculated as follows:

ROI = NOI/Total Investment

ROI = $17,500/$143,000

ROI = 0.122

But what if the sellers had conveyed the property on a timely basis, so that the investor could obtain the lower interest rate? And what is the sellers had delivered a structurally sound property without a costly construction defect? The investor’s total investment would then be only $100,000, and the ROI formula would be 17.5% as follows:

ROI = $17,500/$100,000

ROI = 0.175

The difference between the originally projected ROI of 17.5% and the actual resulting ROI of 12.2% is 5.3%. In other words, the investor’s damages amount to a 5.3% reduction in his ROI.


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So Your Tenant Screwed You. There’s a Formula for That!


If you’re unlucky enough to have rented property to a tenant who didn’t pay you or who destroyed the property, there’s a formula for calculating your actual losses. In fact, there are a number of handy formulas for the damages suffered by property owners due to the loss of rental income. These formulas can be applied whether the losses result from high vacancy rates, market forces, rent collectability problems, or physical property damage. While not perfectly scientific, the formulas provide expedient shortcuts for estimating damages due to lost rental income.

Quick Rental Loss Formula

The quick rental loss formula (QRL) is a handy device for estimating damages caused by nonpayment of rents and vacant office suites or apartment units. Determining the quick rental loss requires the NOI, the anticipated rent increase (RI), the estimated vacancy rate (EVR), and the estimated rental default rate (ERD). The formula is:

QRL = NOI x RI x (EVR + ERD)

Suppose an environmental catastrophe causes 20% of the tenants in an apartment building to cancel their leases or to opt out of renewing their leases. Another 10% of the available units are unrentable because of the stigma created by the nearby environmental calamity. The apartment therefore has an EVR of 30%. Let’s also assume that another 10% of the tenants simply stop paying their rents: thus, an estimated ERD of 10%. Let’s also say that, in this case, the NOI for the apartment building was $65,000. The anticipated RI for the upcoming year is 4%. Let’s apply the formula:

   QRL = NOI x RI x (EVR + ERD)     

            QRL = $65,000 x 1.04 (.30 +.10)

            QRL = $65,000 x 1.04 x .40

            QRL = $27,040

So, based on the figures provided, the anticipated rental loss for the upcoming year will be $27,040. While the QRL formula is not scientifically precise, and in fact is only as valid as the estimates used in the formula (RI, EVR, ERD), it provides a convenient shorthand for calculating damages in a case in which the loss of rental income is the primary setback.

Property Damage Loss Formula

The property damage loss (PDL) formula tells you how much money will be lost as a result of the physical destruction of rental premises by an undesirable tenant or by an external source. The formula essentially calculates the net costs of repairing the premises plus the net market loss. It requires the following pieces of information: the amount of any unpaid rent (UR); the departing tenant’s security deposit being held on account (SD); the total cost of repairs (TR);; the budgeted (anticipated) rent charge for the next rental period (BR); and the actual reduced amount of rent which the market will bear (RR). The difference between the BR and the RR represents the market loss (ML). The formula for calculating the property damage loss is:

            PDL= UR + TR + ML – SD

Let’s plug in some hypothetical numbers. Assume that an uncooperative tenant defaults on the lease and destroys his rental unit prior to his abandoning the property. He has left unpaid rent due of $5,000. The costs for repairing the premises are as follows:

            Painting                                                                   $2.200

            Cleaning                                                                     $900

            Junk Removal                                                             $450

            Key Replacement                                                       $10

            New Carpets                                                               $1,850

            Window Repairs                                                         $260

            Plumbing Repairs                                                       $380

            Refurbishing Woodwork and Other Repairs      $545

            TOTAL                                                                         $6,595

 Assume that the tenant left a security deposit of $7,500 on account. Based on market trends, and assuming that there was no diminution in the value of the rental unit, the unit would be budgeted in the next rental period (or would have an anticipated rental charge of) $3,000 per month, or $36,000 per year (BR). However, because of the diminished quality of the premises, despite the many repairs, the market will only bear a reduced rental price of $2,300 per month, or $27,600 per year (RR). The market loss (ML) is the difference between the BR and RR.

             ML = BR – RR

            ML = $36,000 -$27,600

            ML = $8,400

Let’s put the entire PDL formula together now.

             PDL = UR + TR = ML – SD

            PDL = $5,000 + $6,595 + $8,400 – $7,500

            PDL = $12,495

Therefore, the damages arising out of the tenant’s property damage total $12,495, after applying the tenant’s security deposit to his unpaid rent and to the total repair costs. The outcome of the PDL formula will vary, of course, when all of the components of the formula are not present.

Eviction Loss Formula 

When a tenant is evicted, the landlord suffers the value of his lost rent. This loss, however, must be augmented by any costs associated with the eviction process, and then reduced by any rental payments received from a replacement tenant. The easy formula for an eviction loss is:

             EL = ALR – PR + LF – RTR

 where EL is the eviction loss, ALR is the annual rent charge according to the lease (annual lease rent), PR is the rent actually paid by the tenant (paid rent), LF is the legal fees incurred and court costs associated with the eviction process, and RTS is the replacement tenant payments received.

shutterstock_222722587For example, assume that Christopher signs a lease with Condor Commons, an apartment lessor, to pay $1,500 per month in rent for a one-year lease running from January 1 through December 31. Christopher dutifully pays rent for January through April; then he stops paying. It takes three months to give Christopher notice of the eviction process, and to install a replacement tenant at the same monthly rental amount. The new tenant takes up occupancy of the premises on August 1. Condor’s lawyer charges $450 for handling the eviction case and advancing the court filing and service fees. Let’s do the math:

             ALR = $18,000, based on $1,500 per month for 12 months.

             PR = $6,000, equaling four monthly payments of $1,500 (January through April)

             LF = $450, as the legal fee and court costs

            RTR = $7,500, the total of five monthly payments of $1,500 paid by the      replacement tenant (August through December).

 The EL is calculated as follows:

             EL = ALR – PR = LF – RTR

             EL = $18,000 – $6,00 + $450 – $7,500

             EL = $4,950

So, the loss attributed to the nonpayment of rent by, and subsequent eviction of, the first tenant totals $4,950.

The EL formula can be modified in cases of property damage by adding to the formula the cost of repairs (TR). Thus, for example, if Christopher ruined the carpets because of an untrained dog, and if carpet replacement was estimated at $1,600, the revised formula would look like this:

             EL = ALR – PR + LF – RTR + TR

             EL = $18,000 – $6,000 + $450 – $7,500 + $1,600

             EL = $6,550

 If a security deposit (SD) could be claimed by the landlord, then the amount claimed would be subtracted, extending the formula further. Assume, the court permitted the landlord to claim an SD equal to one month’s rent of $1,500.

            EL = ALR – PR + LF – RTR + TR – SD

            EL = $18,000 – $6,000 + $450 – $7,500 + $1,600 – $1,500

            EL = $5,050

Special provisions contained in a lease may also permit the landlord to claim other losses in the event of an eviction. Any such additional losses should be added to the formula.


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If You’ve Mastered the Magic of 72, You’re Ready to Seize the Secret of 70!

the 70 signYesterday, I spoke about the Rule of 72, a convenient rule of thumb for calculating how long it will take to double your money (or your client’s money) invested in a particular project or purchase. If you missed yesterday’s blog, I encourage you to check it out. You’ll need to give yesterday’s blog a quick read to make sense of today’s blog. 

Once you’ve mastered the magic of the Rule of 72, you’re ready to seize the simplicity of the Rule of 70. 

The Rule of 70 is a variation of the Rule of 72 and works the same way. In order to determine how long it will take to double an investment, simply divide the rate of return into 70. Using 70 as a numerator will produce somewhat more accurate results than the Rule of 72 when interest is compounded daily.

Choosing between the Rule of 72 and the Rule of 70 may depend on simple convenience when making rule-of-thumb estimates without the benefit of a financial calculator. The Rule of 72 will produce easy-to-calculate results when the interest rate matches one of the small divisors (numbers that divide easily into 72 as whole numbers). These include 1, 2, 3, 4, 6, 8, 9 and 12. So, for example, if the interest rate is 9%, the Rule of 72 produces the quickest answer – it will take eight years for any given investment to double.

The Rule of 70 is the better choice, however, when the interest rate matches one of the divisors for the number 70 (1,5,7,10 and 14). A $1,000 investment with a 7% rate of return would take about 10 years to double, a calculation quickly made with the Rule of 70 (as opposed to the Rule of 72).

One of the virtues of these rules is that the amount of money in question is irrelevant to the ratio. An investment of $245,632.01 at 7% would still take about 10 years to double based on the Rule of 70, regardless of the complexity of the exact amount of the funds being invested.

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Happy Financial Independence Day! How Long Will It Take to Double Your Money?

Independence DayThe 4th of July is a perfect day to think about your independence — your financial independence, that is!  So, what if you wanted to double, or triple or even quadruple your money. How long would it take to do that? There’s a handy formula for figuring it out in a matter of seconds. All you need to know is the secret number — 72. 

If you’re a lawyer or a business leader advising a client, the Rule of 72 is a useful technique for estimating how long it will take to double a client’s money, and to restore them to a position of financial power after suffering a financial loss. The magic of 72, however, does not provide a scientifically perfect calculation for doubling one’s money, but rather an estimate, in years, of the doubling time of an investment.

The formula is 72/r where r equals a fixed rate of return. So, for example, if you invested $1,000 at a 4% rate of return, how many years would it take to double the investment? The approximate answer is  72/4, which equals 18. In other words, you could turn $1,000 into $2,000, if invested at 4%, in approximately 18 years. (Had you used a financial calculator, you would have determined that you could have doubled your $1,000 investment at 4% in exactly 17.673 years). For the best accuracy, the Rule of 72 should be used for interest rates ranging from 6% to 10%.

Knowing the Rule of 72 provides an easy ratio for calculating how long it could take a business client to double a capital investment or how long it might take a spouse in a divorce case to reach 100% return on a certain fund of money. Although it is not a substitute for a future value calculation or other more technical determinations, the Rule of 72 can provide quick estimates for negotiating purposes in a wide variety of case scenarios.

Tripling and Quadrupling

Applying the same mathematical logic that underlies the Rule of 72, we can establish two additional related rules: the Rule of 114 and the Rule of 144. The Rule of 114 tells us how long it would take to triple an investment of money at a particular rate of return. The Rule of 144 tells us how long it would take to quadruple the investment. Let’s try a few examples:

Let’s say you want to know how long it would take to double an investment of $100,000, to triple it, and to quadruple it, if you could obtain an 8% rate of return?

To double it, apply 72/r . The answer is 72/8 or effectively nine years to double the money.

To triple it, apply 114/r. The answer is 114/8 or 14.25 years to triple the money.

To quadruple it, apply 144/r. The answer is 144/8 or 18 years to quadruple the money.

Double Your MoneySo, you can now easily estimate that a $100,000 fund, invested at 8%, would double in nine years, triple in five years and three months thereafter, and quadruple in less than four more years.

The various rules can also be used to compare rates of return over time. For example, applying the Rule of 144, with an 8% rate of return, we see that it would take 18 years to quadruple one’s investment. What interest rate would reduce the timeline to approximately 12 years? Apply some simple algebra: 144/r = 12. (In this instance, we already know the number of years, 12. What we don’t know is the rate of return, r.  It is the interest rate that we’re looking for).

To solve for “r”, multiply both sides by r. Your resulting equation is now 144 = 12r. Then divide both sides by 12. Thus: r = 12. And there’s your answer! A rate of 12% would therefore be necessary to quadruple the $100,000 investment in 12 years.



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The Unlucky Landlord! Everybody’s Moving Out, But It’s Not His Fault! Somebody Must Pay For This, and How Much….?

Apartment building 1

Your office building is falling apart. The elevators don’t work. The lights keep flickering, and last Thursday, a fire broke out in the mail room. It turns out the electrical contractor used substandard wiring, in violation of city codes, and now the building inspector is kicking out all of the tenants until the building is re-wired.

Your landlord is losing money left and right. What’s it worth?

The income capitalization approach is the best valuation technique for income-producing properties that have been damaged, or whose value has been impaired by a legally compensable event. Its most common application involves commercial properties that are leased to business tenants and which thereby generate income through rental payments.

There are two income capitalization approaches: the direct capitalization technique, discussed here, and the discounted cash flow (DCF) model, which I’ll be discussing in my next blog.

The direct capitalization technique is based on a simple formula in which the net operating income (NOI) of a property in its first year is divided by the market capitalization rate cap (cap rate). The formula is expressed as:

            Value = NOI / Cap Rate     

That is, Value equals NOI divided by cap rate.

The difficulty lies in determining an accurate NOI and a valid cap rate.

Net Operating Income.

The NOI of a property is equal to the annual income produced by that property after deducting operating expenses. It requires three levels of data:

  1. Potential Gross Income (PGI), which consists of all the gross rents possible, and any other income the property potentially generates, such as parking fees, laundry fees, and vending receipts.
  1. Effective Gross Income (EGI), which consists of vacancy losses and collection losses.
  1. Operating Expenses, which consist of all operational, administrative, and maintenance costs, including utilities, insurance, repairs, and property taxes. However, operating expenses do not include debt service, depreciation, income taxes, and capital expenditures.

            To calculate NOI, first calculate PGI; then apply these two equations:

            PGI – Vacancy and Collection Losses = EGI

            EGI – Operating Expenses = NOI

            The simplified statement of these equations produces this formula:

            NOI = PGI – Vacancy and Collection Losses – Operating Expenses

Let’s plug in some numbers using data from a hypothetical office building known as Trinity Tower.


Net Operating Income


            Gross Rents Possible                                      $175,000

            Parking Fees                                                      $5,200

            Tenant Signage Fees                                         $2,450

            PGI………………………………………..           $182,650

            Vacancy Costs                                                  $5,400

            Collection Costs                                                  $950

            EGI……………………………………….    $176,300

            Utilities                                                           $21,000

            Insurance                                                        $18,500

            Maintenance and Repairs                                $6,750

            Property Taxes                                               $24,100

            NOI………………………………………       $105,950

 Applying the data shown above, we now have the numerator for the direct capitalization formula, that is, the NOI for Trinity Tower. To determine the property value, we must next determine the market capitalization rate.

Market Capitalization Rate.

The market capitalization rate, or cap rate, is often well-known to investors and lenders in a particular market at any particular moment in time. It is generally based on market characteristics and trends (location, crime, property type, and other risk factors). The cap rate is used to estimate the value of income producing properties by reflecting the recent pattern of buyers and sellers in the same marketplace. If we knew the value (or asking price) of a property, and we knew its NOI, then we could modify the value formula, Value = NOI/Cap Rate to determine the cap rate. In other words, if Value = NOI/Cap Rate then Cap Rate = NOI /Value. Thus, using Trinity Tower’s NOI of $105,950, and a hypothetical asking price of $1,100,000, we can calculate the cap rate:

            Cap Rate = NOI /Value

            Cap Rate = $105,950 / $1,100,000

            Cap Rate = 0.096

Therefore, the cap rate for Trinity Tower would be 9.6%.

office buildingThis example assumes that we knew the value of the property. But what if the value of the property is what we’re trying to determine? What if the entire purpose of knowing the cap rate was to activate the first formula, Value = NOI/Value?  In such a case, there are only two choices: either (1) apply a cap rate provided by a reliable investment source based on the most current information, or (2) establish your own cap rate based on bank lending terms and your desired return on equity (ROE). Let’s look at the second alternative.

To derive our own cap rate based on bank lending terms and ROE, we need to gather some data about the financing terms available to purchase the property in question. Let’s assume that a bank is willing to lend $800,000 at 6% interest to be repaid over 20 years. The annual debt service can be easily calculated using an online loan calculator. In this example, the monthly payments on a 20-year loan of $800,000 at 6% would come to $5,731.45. This converts to an annual debt service on the loan of $68,777.40.

Next, calculate the loan constant by dividing the annual debt service amount by the principal amount of the loan:

                                    Loan Constant = Annual Debt Service / Loan Principal

                                                (debt service divided by loan principal)

                                    Loan Constant = $68,777.40 /$800,000

                                    Loan Constant = 0.08597175

This produces a loan constant of approximately 8.6%, which is effectively the bank’s own cap rate for this transaction.

The next step is to determine the ROE. The general formula for ROE is Net Income divided by Shareholder’s Equity.

                                    ROE = Net Income / Shareholder’s Equity

Let’s assume that a buyer in the marketplace would invest $50,000 toward the purchase of the subject property, from which he would expect to generate $7,500 per year in income. Applying the ROE formula, we can quickly determine that this buyer seeks a 15% pre-tax ROE:

                                                            ROE = $7,500 / $50,000

                                                            ROE = 0.15

In effect, 15 % is the investor’s equity cap rate.

We now have two cap rates, the bank’s loan constant of 8.6% and the investor’s ROE of 15%. In order to construct a market cap rate, we need to blend these two rates into one rate. To do this, we will need to determine the loan-to-value ratio (LTV).

The LTV ratio is simply a statement of how much a bank will lend a borrower against the appraised value of a property, expressed in the form of a percentage. It is stated in terms of the amount of money a borrower must borrow (his mortgage principal) divided by the appraised value of the property:

            LTV = Mortgage Loan Amount / Appraised Property Value

In this case, the mortgage loan is $800,000, and the property value is stated at $1.1 million. Therefore, LTV = 73%. In effect, the bank will provide 73% of the financing for the property at its cap rate, and the equity market will provide the remainder at the ROE rate. To blend the rates, we effectively weight the rates according to the LTV percentages. The bank’s loan constant of 8.6% accounts for 73% of the market cap rate; therefore we multiply 0.086 x 0.73, which equals 0.06278. If the bank’s rate accounts for 73%, then the LTV for the equity cap rate is 27%. Therefore, we multiply the ROE of 15% by 27%, or 0.15 x 0.27, which equals 0.0405. By adding the two results (0.06278 and 0.0405), we arrive at a market cap rate of 0.10328, or 10.33%. Here’s a summary of the calculations:

  • Bank’s cap rate (loan constant) = 8.6%
  • Banks LTV debt ratio = 7.3%
  • Bank’s weighted cap rate = (0.086 x 0.73)
  • Investor’s cap rate (ROE) = 15%
  • Investor’s LTV equity ratio = 27%
  • Investor’s weighted cap rate = (0.15 x 0.27)
  • Formula: MARKET CAP RATE = (0.086 x 0.73) + (0.15 x 0.27) = 0.10328, or 10.33%  

Tying It All Together.

Let’s now return to the formula for the direct income capitalization approach:  Value = NOI /Cap Rate. Since we know that the NOI is $105,950 and the market cap rate is 10.33%, we can now calculate the value of the Trinity Tower property:

                        Value = $105,950 / 0.1033 = $1,025,653.44

Therefore, we can now say that a property with a NOI of $105,950 in a market with a cap rate of 10.33% is worth $1,025,653.44.

The same formula can be recast to apply to investment decisions and to set the parameters in legal claims. For example, if Value = NOI / Cap Rate, then NOI/Cap Rate also equals the maximum purchase price a buyer should pay under current market conditions. Likewise, NOI/Cap Rate also equals the optimal amount of settlement or a judgment to be awarded for property damage or impaired property value, assuming that 100% liability has been established and that 100% of the property has been damaged or impaired. If a settlement or a judgment is based on a defendant who is 80% responsible for the impaired value of the property, based on a comparative negligence standard, then the final property value would be multiplied by 80% as follows:

            Value (Based on defendant’s 80% liability) = NOI/Cap Rate

Another variation on the property value formula is to convert the cap rate to a cap factor and then multiply it by the NOI. To convert a cap rate to a cap factor (that is, a multiple), simply divide 1 by the cap rate. In this case, 1 divided by the cap rate of 10.33% is 1 / 0.1033, which equals approximately 9.68. With a cap factor of 9.68, the formula is simply stated:

Value = NOI x cap factor

Value = $105,950 x 9.68

Value = $1,025,596

The property value of $1,025,596 is quite close to the result obtained using the original cap rate formula above, the slight difference being attributable to the rounding of the cap factor.


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Guess What? You’re Buying Me a New House. How To Calculate Damages Using the Cost Approach.

Cost Approach GirlIf the business next door is destroying your property, they may have to replace your property. One way to determine what they’ll actually pay you in damages is the “cost approach.”  Instead of comparing the value of your property to other similar properties in the neighborhood — which is the sales comparison approach which I discussed in my last blog — the offending business may have pay you enough money to buy you a new house, or at least to fix the damage they’ve caused you.  

The basic tenet of the cost approach is that the value of a property, once damaged or impaired by a compensable event, is equal to the cost of rebuilding, repairing, and restoring the property to its undamaged and pre-impaired condition. To calculate a property value using this approach, one must estimate the value of land, the replacement cost of building on the land, and the applicable level of depreciation. In essence, the formula for calculating damages for a ruined property must yield a value that would restore the claimant to an unruined property of equal condition and utility.

Like the sales comparison approach, the cost approach relies on the principle of substitution, holding that the replacement value of a property should be no greater than the cost of comparable land and improvements. The cost approach, however, focuses on cost, not sales, and it targets the cost of the constituent parts of the property, not the property as a whole.

Suppose that a nuclear mishap at a local power plant has contaminated a farmer’s land and rendered his home uninhabitable and his grain silo unusable. Applying the cost approach, we would estimate each cost associated with replacing the property, as follows:

            Step One.       Estimate the value of the land (without improvements).

            Step Two.       Estimate the construction cost of the buildings.

            Step Three.    Determine the depreciation in value of the buildings.

            Step Four.      Estimate any other replacement costs.

            Step Five.       Estimate any incidental and consequential costs.

            Step Six.         Add all the estimated costs; then subtract the depreciation amount.

Damages = Land + Buildings + Other replacement costs, incidental and consequential losses – Loss due to depreciation

Cost Approach GuyIn the case of a nuclear mishap, the cost approach may, in fact, require much more data, rendering the six steps above an oversimplification. For example, it may be impossible to rebuild on the site of the farmer’s land or anywhere nearby. Even if the farmer could safely return to this property, there may be cleanup costs, engineering studies, laboratory analysis, site inspections, and regulatory compliance costs, all before the property can be restored or reoccupied. The value of the farmer’s crops, livestock, grain storage, and other assets would also necessarily need to be assessed.

What if an office building were rendered unusable by the nuclear mishap? A proper expansion of the cost approach might take into consideration any number of incidental and consequential costs, such as:

  • Tenant relocation costs
  • Customer and client notification costs
  • Special insurance endorsements
  • Moving costs
  • Special advertising costs
  • Additional property management or security costs
  • Lease modification and other legal costs
  • Additional operating expenses
  • Lost tenant and extended vacancy costs
  • Furniture, fixable, and equipment (sometimes listed as FF&E)

Not only is it important to account for all of the replacement costs, but it is necessary to recognize all preexisting circumstances that may have reduced the value of the damaged property before the damage was done. For example, a homeowner claiming damages for total loss of his home should not enjoy 100% replacement costs if the home was in disrepair, or had a nonfunctional heating system or a defective roof.

Let’s consider a factually detailed property claim arising from a flood. Assume that Helen Homeowner has a two-story, four-bedroom Colonial-style home in the Oak Village section of town. The home and the adjacent storage shed on the property were destroyed in a flash flood when a cement infrastructure collapsed, breaching a dam on the local riverfront and flooding all of Helen’s land. Helen’s home is 10 years old, and it spans 2,300 square feet. The roof, which has a 20-year guarantee, was severely damaged before the flood. According to contractors, the roof will cost $7,500 to replace. Sheds can be rebuilt for $2,200. The typical life of a home in Oak Village is 40 years. Local vacant lots in Oak Village sell for $25,000. The cost of moving Helen and her salvageable belongings is $3,500.

To apply the cost approach to this factual scenario, let’s return to the original six-step process, this time accounting for the additional information known to us.

The first step is to estimate the value of Helen’s land (without improvements). Vacant lots sell for $25,000; so this will be our first cost.

The second step is to estimate the construction cost of Helen’s home. If we were to build Helen’s home from scratch – a brand new home – the cost would be equal to the square footage multiplied by the builder’s estimate of $75 per square foot.

            2,300 square feet x $75 = $172,500

So the reconstruction costs for Helen’s home will be $172,500.

The third step is to determine the depreciation in value of the property. First we must consider the physical deterioration of the home, specifically the roof. Helen’s property was already 10 years old when the flood occurred, and the roof carries a 20-year guarantee. Therefore, she is entitled to only 50% of the replacement cost of the roof. The roof will cost $7,500 to replace; therefore, we will deduct $3,750.

As for the depreciated value of the home, we will look at the age of the home and its projected life. The home is 10 years old, and it has a projected life of 40 years. Therefore, even before the flood, the home had lost one-fourth (10/40) of its full value. We will thus subtract 25% of the construction cost $172,500.

            $172,500 x 25% = $43,125

As our fourth step, we must look at any other replacement costs. The shed on Helen’s property will cost $2,200 to replace.

Our fifth step is to account for any incidental and consequential costs. In this case, Helen will incur $3,500 in moving expenses.

Our final step is to add all of the costs and to subtract the depreciation costs.

$25,000 (land) + $172,500 (home) + $2,200 (shed) + $3,500 (moving expenses) -$43,125 (depreciation of home) – $3,750 (roof) = $156,325

The value of the property claim – that is, the adjusted damages to be paid to Helen Homeowner – is $156,325.



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