How to Get Rental Property Value With Cap Rate and Gross Rent Multiplier
Cap Rate (i.e., Capitalization Rate) and Gross Rent Multiplier (GRM) are popular real estate investing measures regularly used by real investors and agents to determine whether a rental property is priced according to the local market values and thereby might be a good real estate investment opportunity.
In truth, both measures only provide an estimate of rental property value, and alone, neither provide a true picture of a property's profitability. Nonetheless they can provide a quick first-glance look at whether a property is priced in line with similar rental properties.
In this article we'll look at both measures and the appropriate formulation you can use to arrive at a property's market value the next time you're working with rental income property.
Capitalization rate expresses the relationship between a property's value and its net operating income (NOI) for the current or coming year as a percentage. Here's how to use the cap rate to compute an income property value.
Net Operating Income / Cap Rate = Market Value
NOTE: a) Net operating income (NOI) represents all the property's rental and other income less its operating expenses. b) The capitalization rate you use should reflect the avaerage rate for other similar rental properties in your local market area. Check with a local real estate professional or appraiser if you need help.
Let's say that you're trying to establish a reasonable sale price on small office complex with a net operating income of $40,600, and based upon your research the average cap rate for similar properties is 8.5%.
40,600 / .085 = $477,647
Gross Rent Multiplier
GRM measures the ratio between a rental property's gross scheduled income (annual) and its price expressed as a number. Here's how to use it to to arrive at a rental income property value.
Gross Scheduled Income x Gross Rent Multiplier = Market Value
NOTE: Gross scheduled income is the number of units times their annual rent. This is based on 100% occupancy, so apply a market rent for any vacant units.
Let's say you're considering the purchase of a 5-unit apartment building with a gross rent of $64,000 and want to compute the property's value based on the neighborhood's average GRM of 5.0.
64,000 x .05 = $320,000
The advantage to using both methods is that they are relatively easy to compute. But bear in mind that they are just a precursor to a serious real estate analysis of the property. So don't rely upon either method to make your final real estate investment decision without computing (and validating) all the property's rents, operating expenses and other financial data yourself.
Here's to your real estate investing success.