How Much Do You Know About
An Investor's "Rules of Thumb"?
By James R. Kobzeff

Have you ever been asked about a property's "cap rate"? Or its "gross rent multiplier"? And you stood there gazing like a deer looking into the headlights of a car? Then read on. This one's for you.
Here's a brief description of two of the most common investor rules-of-thumb on the planet. It's not Accounting 101, but it could help eliminate your confusion the next time.

Cap Rate
Simply a shortened version of the term "capitalization rate," cap rate measures the ratio between Net Operating Income and Sales Price. Now, understand net operating income. Mathematically, it's a property's gross operating income less the sum of all operating expenses. In other words, after rents are collected and all operating expenses are paid (i.e., property taxes, utilities, etc.), the amount of money left over to pay the mortgage is the net operating income. As such, consider cap rate simply as "the percentage of sales price available for the loan payment" and you've got the idea

FORMULA: NOI/Price = Cap Rate.
EXAMPLE. If net operating income is $12,000 and the sales price is $150,000, the cap rate is 8% (12,000/150,000). Also indicating that net operating income is 8% of sales price (150,000 X .08 = 12,000). It's a useful way for investors to measure value against preferred acceptable margins.

HINT: If an investor might buy at an 8.5% cap rate, make this calculation: NOI/Cap Rate = Sale Price. In this case, then, you know that the investor's top dollar is $141,000 (12,000/.085).

Gross Rent Multiplier
This is easier, because it simply shows the ratio between rental income and sales price (without regard for expenses).

FORMULA: Sale Price/Gross Rental Income = GRM.
EXAMPLE. If the sales price is $100,000 and income collected from rents is $20,000, the Gross Rent Multiplier is 5.0 (100,000/20,000). Or put another way, the sales price is 5 times the rental income (20,000 X 5.0 = 100,000). It's not as thorough as a cap rate, but this method does provide an investor with a "quick read" on a property; especially when the operating expenses are unknown.

HINT: This is probably the best method for you to use when collecting comparable properties from the MLS because agents seldom include more than the rental income in their listing information.

 

About The Author
James R. Kobzeff is a licensed Broker and apartment specialist in Salem, Oregon. James is also the developer of ProAPOD¾ Multifamily Marketing & Analysis Software. Learn how you can quickly and easily create multifamily reports with ProAPOD¾ at http://proapod.com
James R. Kobzeff
Phone: 503-873-4325
Email: jamesrk@open.org
©2004 James R Kobzeff. All rights reserved.

 

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