I’ve been meaning to start taking a closer look at multi-unit investment properties in our area and working on getting a better understanding of the numbers. I got a call from a buyer recently who was interested in an eightplex in Cameron Park, within walking distance to my house, so I thought this was the opportunity I’d been looking for. One of the first things I wanted to understand was the ratio of income that a rental property in our area generates to its price. There are at least two ways to get at this, one easy and pretty brain dead, the other requiring a little more leg work but worth the trip if you find a property worth investigating further. The two measures are:

• Gross Rent Multiplier
• Market Capitalization Rate (or “cap rate”)

The first number is the more “brain-dead rule of thumb number”, and tells you the ratio (multiplier) of the “gross rent” (go figure) to the sale price or listing price of a property. Of course, using the listing price gives you the gross rent multiplier that the seller has in mind for the property, whereas if you’re looking at comparable sales you’ll generally want to zero in on this value using the sale price. The other number, the Market Capitalization Rate, is the ratio of the Net Operating Income to the sale price or list price. We’ll forego a discussion of Net Operating Income for the time being, but suffice it to say that you need more data points to calculate net operating income and therefore cap rate, but the advantage is that you get a more realistic picture of the value of the property because you’re also taking your operating expenses into account.

The additional data that you need to calculate the cap rate — when coupled with the fact that many listing agents will only enter the bare minimum of data about a property — means that cap rate is not an easy number to determine for a large group of properties (six months worth of comparable sales, for example, or “all the eightplexes available now”). In the case of the Gross Rent Multiplier, you only concern yourselves with two data points and you simply divide. Most listing agents can be prevailed upon to enter the gross rent in MLS, and the price as you’d expect is a required field. (Sadly, however, even in the case of gross rent, many agents will cheat and enter a zero, presumably because they can’t be bothered to do even a minimum of work on behalf of their seller. But let us continue.)

I have more to do in this area and would eventually like to incoporate some of this data either into my duplex listings page or some other new pages in my investment properties section. But meantime I was able to get a rough idea for my buyer of whether a GRM of 14 (quite high on the face of it) was appropriate to Cameron Park. It turns out it is reasonable, though we only have one comp to justify it. On the other hand, a more general area wide number for greater Sacramento for residential income properties sold in the last six months with five or more units would be about 12.26% or thereabouts (see this PDF printout of recent multi-unit sales). That Cameron Park, a generally more desirable / expensive area than some parts of Sacramento, should have a higher gross rent multiplier than the average is not surprising. The authors at the Advantage Software site point make a similar point in their excellent GRM Article. (I’m not endorsing their software — I haven’t used it. But I can endorse Frank Gallinelli’s beautifully lucid introductory book on real estate investment analysis, which is a good deal more inexpensive into the bargain. In fact, if you want to take up the net operating income / cap rate thread, that’s as good a place as any to do it.)

Since GRM is an easy number to calculate, one of the neat things you can do with it is create a list of properties that are ordered from “best investment” to “worst”. I’ve done such a list for five units or more — please pardon the obvious typo. You’ll want to keep in mind as you look at this that you also need to understand location, the vacancy rate, and the operating expenses on the property to make a detailed comparison.

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