Real Estate Investment Ratios
Yes, It is a great time to invest in real estate. But what is a good real estate investment?
Well, it depends....on your objective, your capacity to bear risk, your time frame, amount of time and effort you are willing to put in, how diversified your investments are, what return are you getting elsewhere....
Some Investment ratios that may help in your assessment.
CAP Rate = Net Operating Income/Estimated Property Value
Net Operating Income is Gross Income less Vacancy rate and Operating expenses like maintenance, taxes, insurance, utilities, property management etc. A CAP rate by itself may not be very useful but it helps to compare purchase price of different income producing properties. If the property can be bought at a great value, or if vacancy rates can minimized, CAP rates will be high. Opportunities exist when CAP rates appear low - but better management, improvement or efficiencies can increase Net Operating Income.
Gross Rent Multiplier
GRM = Sales Price/Potential Gross Income.
This does not account for expenses, so helps with comparing income producing properties with similar expenses. Generally speaking, prime locations have higher GRMs. One can estimate the value of an income property by comparing GRMs of recent sales of similar properties. Does not account for expenses, so best to use GRM along with CAP rate.
Cash on Cash Return
Cash on Cash Return = Before tax return Cash flow/Cash invested*100
This compares real estate to other income producing investments. Before Tax Cash Flow is Net Operating Income less Annual Debt Service(Mortgage + Interest). Remember this does not account for investor;s tax situation.
Real estate Investments have 2 unique features - possibility of appreciation over long term and tax deduction benefit which have not been factored into the above calculations.
Hope these ratios helps your real estate investment strategy. For a more personal consultation, call 484 947 3127.