Common Real Estate Investment Analysis Formulas
Gross Rent Multiplier – the ratio of the price of a real estate investment to its annual rental income before expenses. The lower the GRM the better. This doesn’t take into account expenses, and should not be used to determine if a property is a good value.
Price: $450,000 / Annual gross rents: $36,000 = 12.5 GRM
Price: $450,000 / Annual gross rents: $46,000 = 9.8 GRM
Capitalization Rate (Cap Rate) – the ratio of the Net Operating Income (NOI) to the price. The higher the Cap Rate, the better. This is straight return on investment.
Net Income: $24,000 / Price $450,000 = 5.3% Cap Rate
Net Income: $34,000 / Price $450,000 = 7.6% Cap Rate
To work it backwards for pricing properties: i.e. You know the NOI, you think a 6% Cap Rate is a marketable rate.
Net Income $13,000 / 6% = Suggested Price $216,666
Cap Rate does not take condition of the property into consideration. If there is deferred maintenance, the Cap Rate should be higher. Brand new – lower.
Cash on Cash Return – the ratio of the Cash Flow (NOI minus debt payment) to the down payment . Determines the true return on actual investment. The less money down the higher the return will be:
Cash Flow:$2300 / Cash invested: $50,000 = 4.6% Cash on Cash
Cash Flow: $2300 / Cash invested: $36,000 = 7.6% Cash on Cash
None of these factor in depreciation, other tax advantages, mortgage rates, or appreciation. The Net Operating Income is the Gross Income minus the expenses. You have to be careful because Buyers and Sellers tend to determine expenses differently.