Evaluating Investment Property by Peter Fisher There are two key indices that are used to measure investment property, Gross Multiple (GM) and Cap Rate (CAP.) GM is used almost exclusively with residential income properties and CAP is used primarily with commercial and industrial property. CAP is determined by dividing the yearly net income of the property by the price of the property. This is the rate of investment return realized if the property were purchased for cash. A property selling for $1,000,000 with a yearly net income of $100,000 would have a CAP of 10. The higher the CAP, the greater the potential cash flow. GM is a much less precise indice and works in reverse to the CAP. GM is the purchase price of the property divided by the GROSS scheduled income before any deductions for expenses. A property selling for $1,000,000 with a scheduled yearly income of $150,000 would have a GM for 6.67. The lower the GM, the higher the potential cash flow. Obviously cash flow is heavily dependent on interest rates. However, considering the current market, the following is a very rough estimate of the cash on cash return for different investment strategies. Cash on cash is the yearly percentage return determined by dividing the yearly cash return by the initial cash investment. All investment scenarios assume a 25% down payment and 75% in debt.
The property rating is a general property rating based primarily on the location of the property. "A" rated properties sell for higher GM’s and produce a lower cash flow. The trade off is that better areas may have less vacancy, fewer management problems and lower maintenance. They have the potential for more rapid rent increases and more attractive financing.
The property rating for commercial and industrial properties is also related to location but is more heavily weighted towards the type of tenant. For example, a single tenant K Mart could offer a CAP of 8. Better tenants offer more stability, less vacancy and better opportunities for attractive financing. [About
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