The following performance ratio can be used by investors to assist in properly analyzing potential investment opportunities. Wise investors who elect to master these principles will no doubt gain greater insight into property values and their worth relative to alternative opportunities.
1. GROSS RENT MULTIPLIER (G.R.M.)
The gross rent multiplier measures the relationship between the total purchase price of a property and its gross scheduled income. It is the ratio of price to income. The G.R.M. calculation is made as follows:
Gross rent multiplier = purchase price gross scheduled income = G.R.M.
The Gross Rent Multiplier is similar to the cap rate in that it captures the relationship between revenues and price; however Cheap JaVale McGee Jersey , there are two primary differences. The first is that while the G.R.M. measures the relationship between gross revenues and price, the cap rate measures the relationship between net revenues, or N.O.I., and price. The second difference is that one ratio is inverted compared to the other. For example, purchase price is the numerator in the G.R.M. quotient, but it’s the denominator in the cap rate. While a higher cap rate is preferred to a lower cap rate Cheap Patrick McCaw Jersey , a lower G.R.M. is preferred to a higher G.R.M. This is true because the ratio will decrease the lower the purchase price is relative to income. It will also decrease the higher the income is relative to the purchase price.
For examples, the G.R.M. of 5.09 measures the relationship between the total purchase price and the gross scheduled income in Year 1. (If the purchase price is $1,002,00 and gross scheduled income is $196,800)
Gross Rent Multiplier = $1,002 Cheap Nate Thurmond Jersey ,000 $196,800 = 5.09
In the model used to make the calculation, both improvements and closing costs have been factored into the analysis. Although there are no improvements in this example, they are typically included if major capital expenditures are expected. If the improvements are expected to increase the gross revenues, that, too Cheap Rick Barry Jersey , should be taken into consideration. The G.R.M. can be calculated on either an as-is basis with no changes or improvements to the property, or on a pro-forma basis, which includes both improvements and the expected increase in revenues that would result from the improvements.
2. OPERATING RATIO
The next performance measurement used to analyze income producing properties is the operating ratio (OR), which is the ratio between total operating expenses and gross income. Like the operating efficiency ratio, it provides a gauge of how efficiently a given property is being operated. Whereas the O.E.R. measures efficiency relative to a property’s total square footage, the OR measures efficiency relative to a property’s income. The calculation is made as follows:
Operating ratio = total operating expenses gross income = OR
Depending on the type of income property Cheap Mitch Richmond Jersey , an OR can range from about 30 percent to as high as 70 percent or even more. Commercial properties tend to have a lower OR since most of the expenses are passed through to the tenant. Multifamily properties, on the other hand, tend to have a somewhat higher OR since the expenses that are passed through. For example, an apartment building being operated as an “all bills paid” property will certainly have higher expenses relative to its income compared to a similar property in which the utilities are paid by the tenants.
For examples illustrated the OR of 58.5 percent measures the relationship between total operating expenses and gross income and is calculated as follows:
OR = $120,000 $204,960 = 58.5%
The result in this example of 58.5 percent is somewhat on the high side Cheap Chris Mullin Jersey , but does not fall outside the range of normal ratios. An investor looking to create value in an income-producing property would carefully examine each factor that contributes to the operating expenses. In other words, a high OR may signal that repairs and maintenance are abnormally high, or perhaps that management expenses could be trimmed. Conversely, an unusually low OR could signal that not all of the operating expenses are being reported. If repairs and maintenance, for example, are known to average 10 to 15 percent of gross income but are being reported as only 3 or 4 percent Cheap Latrell Sprewell Jersey , then either the property is in exceptionally good condition or not everything is being reported.
3. BREAK-EVEN RATIO
The final investment performance measure we examine is known as the break-even ratio (B.E.R.), which measures the relationship between total cash inflows and total cash outflows. The B.E.R. is similar to the OR in that both ratios use total operating expenses as part or all of the numerator and gross income as the denominator. The difference between the two is that the B.E.R. includes as part of the numerator the debt service. The B.E.R serves as a performance measurement of cash flows from a property, and the OR serves as a performance measurement of income and expenses.
As the break-even ratio’s name implies, the break-even point is the point at which the total cash inflows are exactly equal to the total cash outflows. A property with a negative cash flow has a ratio greater than 1.0, which means that its cash outflows exceed its cash inflows; conversely, a property with a positive cash flow has a ratio less than 1.0 Cheap Wilt Chamberlain Jersey , which means that its cash inflows exceed its cash outflows. The break-even ratio is calculated as follows:
Break-even ratio = (total operating expenses + debt service) gross income = BER
For examples, the B.E.R would be calculated by adding the total operating expenses of $120,000 to the debt service of $61,276 and then dividing this sum by the property’s gross income of $204,960. Take a moment to review the calculation.
BER = ($120,000 + $61 Cheap Tim Hardaway Jersey ,276) $204,960 = 88.4%