Five Key Real Estate Investing Terms

After taking last week off to write about local goings in my blog I am back to my weekly piece about real estate investing.

Today’s blog highlights five real estate investing terms you should be familiar with along with an overview as to why they are important.

Gross Rent Multiplier-  This is a ratio of purchase price to gross annual rents.  This can be a good early indicator of the quality of the investment.  However, when comparing properties you must keep in mind that this doesn’t take into account any owner paid utilities or other bills.  Be sure to include vacancy rate when calculating.

Monthly Cash Flow-  Pretty straight forward with this one.  But maybe in the end what allows you to stay in the game and withstand any downturn.  This one is simply gross rents collected, minus all payouts including any debt service, insurance, maintenance….etc.

Cash on Cash Return- This equation calculates how much of a first year cash return on your investment.  You take the annual cash flow and divide that into the total cash you invested for down payment and closing costs and you get the cash on cast return.  This is my personal #1 measuring stick for the value of an buy and hold investment.  Once you see some of these returns you will put a lot more of your investment money into real estate.

Net Operating Income- Another simple calculation that essentially measures what a property’s cash flow would be without the debt service.  This is calculated by taking the gross rents and subtracting out all operating expenses, but be sure not to take out the debt service payment.

Cap Rate-   A ratio used more frequently in commercial investing, but it still has its place in residential and is a little more inclusive ratio that gross rent multiplier.  Calculate by taking the net operating income and dividing it by the purchase price.  This ratio will tell you how long it will take for this asset to pay for itself in net operating income.  If you have a cap rate of say 6%, this property will pay for itself in  about 16 ½ years without any appreciation.  Many investors set a figure for this and won’t seriously look at properties below that cap rate or even better value it based on that cap rate.  The higher the cap rate the better.

Sample Calculations:

GRM Calculation: Purchase Price $150,000, gross rents-$30,000= 5.0 GRM(150,000/30,000)

Cash Flow Calculation: Gross rents collected-$3,000, total expenses-$2,800= $200 cash flow.

C-O-C Return: 1^st year cash flow:$12,000, total cash invested-$38,000=31.5% COC return(12,000/38,000)

NOI(net operating income): Gross rents collected $3,000, total operating expenses- $2,000=$1,000 NOI

Cap Rate: NOI of $18,000, purchase price $200,000=9% cap rate(18,000/200,000)