|
|
|
Say Goodbye To The Gross Rent Multiplier
ou may be familiar with a crude way to put a value on a
the gross rent multiplier. property. It is just too
This simple formula for simplistic. Suppose two buildings
determining the value of rental each are selling for eight times
real estate has been around for their gross annual rent
ages. The first book I read on collections. One however,
investing in real estate advised includes all utilities in the
me to "never buy a property with rent that tenants pay. That
a GRM of more than 8." GRM is the changes things, doesn't it? Of
acronym for gross rent course, you could try to subtract
multiplier, of course, and the out the utilities, to see what
formula is this: divide the price rents would be if they weren't
by the gross annual rents to get included, and use that for the
the GRM. GRM. But that's not the only
problem.
In other words, the author was
advising me to never pay more You need to constantly change the
than 8 times the annual rent for GRM expectations to reflect
a rental property. That seemed interest rates, because a
simple enough. I started looking property might be profitable at
at properties in terms of GRMs. 12 times rent when interest rates
If it was selling for 6 times are low, but a money loser at
rent it must be a good deal. If eight times rent if the financing
it was 12 times rent it had to be is expensive. Also, there are
bad. It was great to have such a just plain different expenses for
simple rule to follow - except different properties, whether
that it never was a good rule to higher maintenance costs,
begin with. insurance premiums, or whatever.
Gross rent doesn't say much about
Using a gross rent multiplier is the factor that really makes a
rental property valuable: the net capitalization rate is .10 in
income. your area, meaning investors
expect a 10% return on the value
Valuation Using Cap Rates of their investment. You can use
your own rate, of course, but if
You buy rental properties for the others are paying more you may
income they produce, right? Then have a tough time buying
this is what your real estate anything. Now divide the net
valuation should be based on. income of $46,000 by .10, and you
That is why you need to how to get $460,000 - the estimated
use a capitalization rate, or value of the building. With a cap
"cap rate" to determine value. A rate of .08, meaning an 8%
cap rate is the rate of return return, the value would be
expected, or the rate of return $575,000.
on a property at a given price.
Looked at the other way around,
An example will make this clear. to see what the cap rate is based
Start with the gross income of a on the asking price of a
property and subtract all property, just divide the net
expenses, but not loan payments. income by the asking price. For
Suppose the gross income is example, if a seller wants
$80,000 per year, and the $675,000 for a property, and the
expenses are $34,000, you have net income is $55,000 you would
net income before debt-service of divide 55,000 by 675,000. This
$46,000. To arrive at an estimate gives you a cap rate of .81.
of value, apply the
capitalization rate to this Value equals net income before
figure. debt-service divided by cap rate.
This is a simple formula, but the
Let's suppose the normal tough part is getting accurate
income figures. Be sure the including this income, and then
seller gives you ALL the normal add back the replacement cost of
expenses, and doesn't exaggerate the machines, which is probably
income. Suppose he stopped much less than $75,000.
repairing things for a year, and
is showed "projected" rents, Of course if you are competing to
instead of actual rents buy properties based on the same
collected. The income figure cap rate used by others, but you
could be $15,000 too high, which have to borrow at higher interest
would cause you to estimate the rates or buy with less of a down
value at $187,000 more (.08 cap payment, you could have cash flow
rate). Ouch! problems. Don't let formulas get
in the way of thinking through
Smart investors sometimes all the factors. No simple
separate out income from vending valuation formula is perfect, and
machines and laundry machines. If all are only as good as the
these sources provide $6,000 of figures you plug into them, but
the income, that would normally using cap rates is certainly
add $75,000 to the appraised better than using gross rent
value (.08 cap rate). However, multipliers.
you can do the appraisal without
About the Author:
Copyright Steve Gillman. Avoid mistakes when buying rental properties. Go get your free due diligence checklist at http://www.HousesUnderFiftyThousand.com/due-diligence-checklist.html
Read more articles by: Steve Gillman
Article Source: www.iSnare.com |
|
