Work with a broker that knows what he or she is doing, preferably a CCIM. Simple analysis goes only as far as cap rate or gross rent multiplier (GRM). While cap is beyond most residential real estate agents it does serve as a base to compare property (usually there is a "going" cap for a particular type of property in a particular area). However cap only looks at 1 year and does not take into account debt, multiple years, vairable cash flows or a future value (you need IRR for that). You may want to look a capital accumulation as well as IRR when comparing property? Capital accumulation will tell you what you really want to know, how much money will each property generate over time? Cap merely tells you the relationship of the price to the income (as a percentage) now, which can be compared to other properties caps. What it won't show is how they compare over time (again IRR is needed).
Cap is easy to figure. NOI/Price= CAP. While it may be easy, it is not particually good (because of its limitations). It is widely used because it is easy. GRM is even less accurate. I'll give you an example: GRM is 10. 10 X $10,000 gross income= $100,000 property value. Let's say expenses are 25% so the NOI on the property is $7500 and the going cap rate for the area is 8%. $7500/.08= $93,750 property value. A 6% cap = $125,000 and a 10% cap= $75,000. Do you see how inaccurate GRM is? If on that same property you paid $93,750 (an 8% cap), got a loan 75% LTV @ 6% amortized 30 years and sold the property at the same cap in 5 years as you purchased, 8%, your IRR before tax would be 10.5%. You would have made 10.5% on your money during that time. At the 10% cap price 19.8% . If you purchased using the GRM method at $100,000 your return would have been 8.3%.
Please feel free to contact me at email@example.com or 800 554-7362 ext. 208 for more information.
Paul Sylvester, CCIM
Jun 10, 2009