Cap Rates and Gross Rent Multipliers

[Sippy Hira]

I'm trying to get my head around cap rates and gross rent multipliers.  I have a basic understanding of both, however, I've been told that for multi-family properties, I should pay more attention to the gross rent multiplier than cap rates.  Any advice on how to best evaluate if a duplex, tri or any multi family is worth investing in? What are the key financial metrics we should be looking at? Also, is a high or low cap rate better when reviewing properties?  Where just starting out in this space and doing our best to learn, but feeling a little overwhelmed with all of this information.  All advice is welcome!

[Jeff Kehl]

@Sippy Hira If you're just starting out, I would ignore gross rent multiplier, cap rates and all the other financial mumbo jumbo. Use the financial calculators here on bp or do your own spreadsheet if you're comfortable with that. The key is to understand the income, expenses and profit or loss. How much is the rent and what are the expenses. Use some of the 'rules of thumb' to sanity check it.

Here's a simple example. Duplex that costs $100k and rents for $500/unit/month or $1000 total. 1% Rent/Value.

Simple P/L

Income $1000

Vacancy 10% $100 

Repairs 10% $100

Taxes 10% $100

Insurance 5% $50

Management 10 % $100

Capex (Big repairs) 5% $50 (saved in bank for future repairs)

Total Expense 50% $500

Net Operating Income  $500/month $6000/year

Downpayment $20k

Mortgage Payment ($80k 5% 30 years fixed): $429

Cashflow: $71/month $852/year

Cap rate: $6000/ $100000 or 6 %, the higher the better because you're making more money

Coc return: $852/$20000: 4.26% not great 

GRM = $100,000/$12,000 = 8.33

This deal cashflows but is not great why? you are paying a 6 cap and financing it at 5 %. There is not a lot of difference there. If you buy a 10 cap and finance it for 4% it will look a heck of a lot better. 

There are also a lot of other variables not shown in this simple example.