“How Can I Quickly Figure Out If This Is A Good Deal?”

“Here Are The ‘Rules Of Thumb’ For Quickly Analyzing A Property.”

By Van Sturgeon

Real Estate Investor

There are so many variables to consider when analyzing an investment property. There is the physical condition, the area that it is located, and the amount of upside on rents if you make some renovations to the property. 

Those are just some of the many things that you have to consider when making that investment in real estate.

For the newcomers to the real estate investment world, there are a few quick methods that investors use when determining whether a property is worth further investigations or to use for comparisons in a general area.

Now, keep in mind that this is a fast way to determine if the property is worth anymore of your time. You always want to do your full due diligence before any deal goes firm.

So...the two valuation methods are CAP Rates & Gross Rent Multiplier. CAP Rates & Gross Rent Multiplier are two ways that are frequently used by real estate agents and real estate investors to quickly place a value on a rental property.

Let’s take a closer look at how you can use these evaluation methods and how you calculate the value…

CAP Rate or Capitalization Rate.

Cap rate looks at the relationship between the properties value and its NOI (Net Operating Income) for the current year.

NOI is all the properties rental income and any other income minus all the property expenses (except mortgage payments). It is as if you paid all cash with no mortgage on the property.

This is the truest indication of what the return on investment would be if you took a snapshot of the current conditions of the property and the area.

Market value is the list/sale price of the property.

NET OPERATING INCOME / MARKET VALUE ( LIST PRICE ) = CAP RATE

Now let’s take a look at how you can use CAP Rate to estimate the rental properties value.

1. Determine what the CAP rate is for a similar property in your investment area. If you need help with this, reach out to a local real estate professional or do some research on the internet. There is a lot of information on specific areas and the average CAP rate.
2. Use the following formula to determine the estimated value of the property you are looking to buy.

NOI / CAP RATE = MARKET VALUE

Let's take a look at an example so that you can gain a better understanding of how this works. Let's say that you are trying to figure out what the reasonable sale price or market value is for a small 4 unit property. The property has a NOI (Net Operating Income) of $43,000 and based on your research the average CAP rate in that area for a similar four unit rental property is 4%

Result: $43,000 / 4% = $1,075,000

Gross Rent Multiplier

Gross rent multiplier measures the ratio between your properties gross scheduled income and the list/sale price. Gross scheduled income is the number of rental units in the property multiplied by their ANNUAL rent based on 100% occupancy.

Apply a fair value market rent to any units that are currently vacant. Price is the list/sale price the seller wants for the property.

PRICE / GROSS SCHEDULED INCOME = GROSS RENT MULTIPLIER

So...Here are the steps that you need to take in order to use Gross Rent Multiplier as a basis to do a comparison or an evaluation on a property.

1. First, you need to figure out what the GRM (Gross Rent Multiplier) is for your area for other similar properties that you are looking to compare. Again...this information is available from a real estate professional or on the internet.
2. Apply this formula when you want to calculate an estimated value for the rental property that you are analyzing.

GROSS SCHEDULED INCOME X GROSS RENT MULTIPLIER = MARKET VALUE.

Let’s use an example so that you can gain a better understanding of how this works. If we assume that you are looking to purchase a four unit rental property, and the property you come across has a gross rental income of $42,000. Through your relationships with a couple of real estate agents in the area, you have determined that the 8X is the going rate for a similar property.

The next step is to use 8X to the $42,000 to determine a value for the property. This is what it looks like :

Estimated Value: $42,000 x 8 = $336,000

Now that you understand how to use these two methods to easily determine an estimated value on the property you want to buy I have got to warn you…

What I have shown you is simply the first step among many steps you need to take before you should come to a conclusion on whether to buy a property. You must do a lot more due diligence before you can truly determine if the property is worth buying.

In fact, my success has come from diving into a deeper analysis of properties that have a too high or a too low of a number in comparison to other properties in the area. Usually, this is a good indication of a poorly managed property, or a property that needs a capital investment in upgrading the physical condition.

NEVER rely on either of these methods to make a buying decision. As they say…”The Devil is in the Details”.

For more information on house renovations and real estate investing, visit www.vansturgeon.com to help you in your real estate investment journey.