When evaluating multi
residential income properties that are for sale, in order to decide how much to
offer or, to compare two unlike properties, among other things, investors will
look at two financial numbers, the Gross Rent Multiplier (GRM) and the
Capitalization Rate (CAP). By calculating
these two values, it may for example, help you decide how well priced a duplex
in a high rent area compares to a fourplex with lower per unit rents.
GRM = Purchase Price/Annual Gross Income
The GRM is the purchase
price divided by the annual gross income. The result gives you the number of
years it takes for the gross income to make up the purchase price. The nice
thing about this calculation is only minimal financial information about the
property is needed and it can quickly tell you if the asking price is out of
line with other properties you are
considering. It is important to be consistent with what you use for gross
income when comparing properties. I
prefer to use my own estimated market value rents as opposed to current tenant
rents. You can use the maximum potential rent or make an allowance for some
vacancies. I also prefer to include the income from coin-op laundry machines.
The downside of the GRM calculation
is that ignores operating expenses. So while two properties may appear to be of
equal value based on a GRM calculation, you may find one has significantly more
operating expenses than the other. For example, with the duplex each tenant
pays their own utilities, where in the fourplex you find there are not separate
water meters, so water is paid by the landlord. The CAP rate looks at both
income and expenses. Once you can obtain
expense information on your potential purchase you can then make this calculation.
CAP% = Annual Net Income/Purchase Price
* 100
The CAP rate is the annual net
income divided by the purchase price, usually expressed as a percentage. If one
ignores the tax advantage of rental income and appreciation of property values,
then you can consider the CAP rate as the return on your investment.
The annual net income is the
gross income you used in the GRM calculation minus all annual operating expenses.
Common operating expenses paid by you, the landlord, may include:
·
Property taxes
·
Insurance
·
Garbage service
·
Landscaping services
·
Water and Sewer
·
Gas and Electric
·
Maintenance and Repairs
·
Property Management fee
·
Vacancy factor (if not included in the
gross rent calculation)
If you borrow money to make the purchase you
will have a mortgage payment. This expense is not considered an operation
expense (it’s the cost of borrowing capital) and not included in the calculation.
Example: Purchase Price = $900,000 Gross Income = $65,000 Net
Income = $45,000
GRM = $900,000/$65,000 =
13.85 CAP% = $45,000/$900,000
* 100 = 5%
When comparing
properties, a smaller GRM is better and a larger CAP rate is better. Often
these values will be provided to you by the listing broker or on the MLS.
However, it is important to understand how these values were derived. I have
found that often a vacancy factor was not included, property taxes were based
on the seller’s rate and maintenance and repair costs were understated. It is
best to get as much information as possible from the seller, and then make your
own adjustments and calculations.
