Commercial Property Numbers
It’s true that real estate can offer benefits of diversification in one’s portfolio, income, tax benefits, etc. However, if you don’t know what you’re doing or how to project income, costs analysis, or evaluate potential appreciation, you really don’t have any idea whether you’re making money from it.
For most, it’s the bottomline between the original costs and price of property being sold for. The net will the profit. Seasoned investors and corporate owners would typically determine the potential outcome with cap rate, gross rent multiplier, discounted cash flow, internal rate of return, etc. These are used to determine whether certain property makes scense to buy or sell. So, what do they really mean? How do you run these numbers? Here’s a couple of definition examples.
Gross Rent Multiplier (GRM) — if you multiply a property’s gross rent by a particular mulitplier, you’ll get an idea of the market value. It’s similar to analyzing a stock with P/E ratio for the fair value stock price.
Cap (capitalization) Rate — dividing net operating income by sales price. It’s a quick way to how cheap or expensive the listing price is. Buyers will look for a high cap rate.
Discounted Cash Flow — this takes into account of time value of money. It matters when you invest into a certain property. For example, if you expect to make 10% on a similar property, all of the expected future income on the current property including annual cash flow and eventual sales proceeds will be discounted by 10% per year. If the present value of income is higher, then it’s a better investment.
Internal Rate of Return (IRR) — this takes into the calculation of net operating income, cash flow, projected market value, and eventual sales proceeds before taxes. The IRR is to help you determine the appropriate price of a property, expected income, and anticipate future sales price so to help structure a smart deal.
Aside from the above samples of technical analyzers, you should also consider local economy and location before making a big purchase. The bottom line is that income properties don’t automatically make you money. If you are looking to buy into a commerical property, your CPA can help run these analyses for more details.
I consider these definitions as being very useful because there are moments when people talk about something, but you don’t know for sure what that word means. There are some aspects of the real estate market you have made them clear.