The analysis of income property has a vocabulary of its own. When you are looking over potential units for purchase, these terms will often be mentioned or included in the reports.
Cap Rate (Capitalization Rate) – Cap rate or “cap” is very similar to an interest rate, such as on a bank CD or savings account. Cap rate is the standard starting point when reviewing an income building. The property cap rate provides an expected annual income return percentage rate by comparing the income after expenses to the purchase price. Note that loan payments are not included because those would vary by each purchaser’s terms. The equation:
- Cap Rate = (Annual Rental Income – Annual Expenses excluding loan payments) / Purchase Price.
- The simple version: Assuming a cash purchase, after expenses what kind of return could I expect on this building.
Gross Rent Multiplier (GRM) – Gross rent multiplier gives a snapshot of the ratio of purchase price to the rents. The gross rent multiplier is a simple tool to quickly compare buildings to each other. With an average GRM for a neighborhood or city, you can also compare a building to the surrounding competition. GRM ignores all expenses which is why it uses the gross operating income.
- Gross Rent Multiplier = Purchase Price / Annual Gross Income
- The simple version: How many years would it take for me to make back the purchase price at the current rental rates and not paying any expenses.
Operating Income – This comes in two formats, gross and net, which are usually presented in yearly totals. The gross operating income is the sum of all rental and other income the property generates. The net operating income is what remains of the gross income after expenses have been deducted.
Expenses – Some unit listings will include the yearly expense numbers or percentage, though it is rarely very detailed. Once an offer is accepted you should review the last 12 months of accounting reports from the owner or their property manager. Utility bills, upkeep and general ownership costs should be listed along with details on rental and any other income generated by the property.
– Josh Toering
(310) 525-9440 or Email