Making Sense of Dollars and Cents

As an investor, you have a unique investment strategy, threshold for risk, and desire for return on your investment. Ratios like GRM, NOI, and Cap Rate can identify properties that warrant deeper investigation as a financial asset. You can address fundamental purchase questions like: 

• Does this opportunity match your investment strategy?
• How much income do you expect to earn each year?
• Should you reduce costs or increase income?   

Now, let's look at a few stats in more detail...

GRM stands for Gross Rent Multiplier. The Gross Rent Multiplier is the ratio of the purchase price to annual gross income (before expenses) generated from rents. For example, the GRM for a property that generates $300,000 in rents each year and is offered for sale at $3.5M is $3,500,000 / $300,000 or approximately 11.7.

NOI stands for Net Operating Income. The Net Operating Income is the annual gross income LESS expenses. Expenses can include real estate taxes, maintenance, management, repairs, utilities, and more. For example, the NOI for a property that generates $300,000 in rents each year with $75,000 of annual expenses is $225,000.

CAP is short for Capitalization Rate.  Simply put, it is a measure of the annual value returned from a real estate investment, based on the income generated.  Another way to think about CAP is an indicator of the percentage of the purchase price that an investment returns each year.  For example, a property bought for $4,000,000 and that $225,000 in NOI each year has a CAP of $225,000 / $4,000,000 or 5.6%.

Each of these figures describes the finances, potential or risks of a property.  Together these figures (and others) can paint a financial picture of an property as clearly as floor plans show the layout of a property.  As a smart buyer or seller, real estate stats can help you spot where dollars make sense! 

You can also estimate the current market value for a property by calculating the NOI divided by CAP.  In the following chart, the NOI generated (row) and desired CAP (column) provides one estimate of the investment value of a property.  

		Cap Rate
	NOI	5.00%	6.00%	6.50%	7.00%	9.00%
	$25,000	$500,000	$416,667	$384,615	$357,143	$277,778
	$50,000	$1,000,000	$833,333	$769,231	$714,286	$555,556
	$100,000	$2,000,000	$1,666,667	$1,538,462	$1,428,571	$1,111,111
	$125,000	$2,500,000	$2,083,333	$1,923,077	$1,785,714	$1,388,889
	$150,000	$3,000,000	$2,500,000	$2,307,692	$2,142,857	$1,666,667
	$175,000	$3,500,000	$2,916,667	$2,692,308	$2,500,000	$1,944,444
	$200,000	$4,000,000	$3,333,333	$3,076,923	$2,857,143	$2,222,222
	$225,000	$4,500,000	$3,750,000	$3,461,538	$3,214,286	$2,500,000
	$250,000	$5,000,000	$4,166,667	$3,846,154	$3,571,429	$2,777,778

I consult this chart to see the relationships between NOI, CAP, and value.  Why?  You may want to compare the return for properties at two different price points to see which is a better deal.  You can use the CAP rate calculation  to level the field.  Imagine you are considering two properties:  The first property generates $25k in NOI and offered at $415k or another property that generates $50k and offered at $900k.  Which offers a better return?  The first property yields a 6% CAP (25k/415k) while the second yields a 5.55% CAP (50k/900k).  

The bottom line: Property stats aren't just for Big Deals....as savvy buyers and sellers you should know how a property stacks up financially to other property.