If you are in the market for a duplex, triplex, fourplex, or 5+ unit multi-family investment property, you have undoubtedly come across these terms. To further familiarize yourself with income property, there are some key terms you should know:
Operating expenses include maintenance and operating costs for an investment rental property. Operating expenses include property taxes, utility costs, insurance, routine maintenance and repairs, advertising, attorney fees, licensing, leasing commissions and so on. Expenses not considered as operating expenses are home improvements, income taxes, mortgage interest, loan origination fees and personal property.
Gross Scheduled Income (GSI):
Gross Scheduled Income is the gross annual rental income of an investment property assuming that all units are 100% occupied and payments are received on time. To calculate the GSI of an income property, use this formula: [Number of Units] x [Monthly Rent per Unit] x 12 [Months in a Year] = GSI. For example, to calculate the GSI for a triplex with two units rented at $1,000/month and one unit rented at $800/month: 2 x $1,000 x 12 = $24,000; 1 x $800 x 12 = $9,600; total GSI = $33,600
GSI = [Number of Units] x [Monthly Rent per Unit] x 12 [Months in a Year]
Gross Operating Income (GOI):
Realistically, units are not occupied 100% of the time and renters do not always pay their rent on time. In this case, investors use Gross Operating Income is used to deduct vacancy rates and credit loss from the Gross Scheduled Income. To calculate GOI, use this formula: [GSI] x [Percentage of vacancy and credit loss] = GOI. Suppose the vacancy rate for the area surrounding the property's location is 4% and you predict an annual credit loss averaging 3%, for a total of 7% annual vacancy and credit loss. This is how you would calculate your GOI using the GSI in the previous example: $33,600 x 0.07 = (total GOI) $2,352.
Net Operating Income (NOI):
Net Operating Income is an investment property's gross annual income after operating expenses are deducted. NOI determines the overall value of an investment property.
NOI = GSI – Operating Expenses
Capitalization Rate (Cap Rate):
Capitalization Rate is the annual return on an income property based on the property's expected income. To calculate a property's Cap Rate, use this formula: Net Operating Income / Sale Price = Cap Rate. For example, suppose you purchase an income property for $870,000 and it generates a Net Operating Income of $90,000. This is how you would calculate your Cap Rate: $90,000 / $870,000 = 0.10, or a Cap Rate of 10%. The higher the Cap Rate of a property, the higher the return for the investor.
Cap. Rate = NOI / Sales Price
Gross Rent Multiplier (GRM):
Gross Rent Multiplier is a ratio used to measure the cost of an investment property to its gross annual rental income. To find the GRM of a property, use this formula: Property Sale Price / Annual Gross Scheduled Income = GRM. Expenses such as utilities, vacancies, maintenance, insurance and property taxes are not included in this calculation. To find the approximate value of a property, use this formula: GRM x Annual Gross Scheduled Income = Property Sale Price. GRM is used to assess a property’s value by comparing it with similar, recently sold income properties. The lower the GRM of a property, the higher the return for the investor.
GRM = Sale Price / Annual Gross Scheduled Income
For more information about investment properties in the Puget Sound Area, please visit our multi-family property page. http://www.soundmultifamily.com/
By Charles Burnett, Seattle Area Multi-Family Investment Property Specialist | Sound Realty Group