Income and expenses determine the value of a building
Two value determining approaches are Capitalization Rate and Gross Rent Multiplier. Both are quick and easy ways to decide how a property financially compares to other properties.
The Capitalization Rate (also known as CAP rate) is used with rental real estate to indicate the rate of return that is expected from a rental property. The CAP rate represents the yield of a property over a one-year time period assuming the property is purchased with cash.
The Gross Rent Multiplier (GRM) approach values rental property based on the amount of rent the building collects each year. This is before any taxes, insurance, utilities, and other expenses associated with the property are subtracted.
A property is offered for $1,000,000, with an annual income of $90,000. Fixed operating costs and property taxes are $30,000 annually (does not include loan repayment).
To calculate its CAP Rate you subtract the operating cost of $30,000 from the income of $90,000 leaving net income of $60,000.
The capitalization rate formula is: $60,000 ÷ $1 million = 6%.
If the CAP rate is lower than other properties, it is priced higher than the rest of the market.
A property is offered for $1,000,000, with an annual income of $90,000.
To calculate its GRM, we divide the sale price by the annual rental income.
The GRM formula is: $1,000,000 ÷ $90,000 = 11.11.
If the GRM is higher than other properties, it is priced higher than the rest of the market.
This spreadsheet is used to give understandable comparisons for different buildings currently on the market and what recently closed in the area you are searching. More importantly, use the spreadsheet to show the results of "value add" changes you could make. Cost, loan terms, expenses and income can be adjusted to see how a building will preform with your plan factored in.
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