Traverse City Record-Eagle

Real Estate News

August 20, 2012

Investment Property? 5 Ways to Crunch the Numbers

(Continued)

Syndicated —

Internal rate of return and net present value

Two other common methods for evaluating real estate investments are internal rate of return and net present value. Both take into account the time value of money theory, and both are more complicated than I can explain here. However, although these are well-known and heavily used in the commercial arena, in my opinion they have one fatal flaw: Both of these calculate a rate of return based heavily on a future sale of the property and an estimated price that the property sale will generate. There's the problem, the "estimation" factor. So someone can estimate whatever outrageous sale amount they project for 7-10 years down the road, and it will make either of these two measures show the property to be a great deal! The question is: Will those projections come true? Often they do not.

Gross rents multiplier

There is also gross rents multiplier (GRM), which takes the property price and divides it by the gross rents the property can generate. So if the price is $100,000 and the annual rental income is $10,000, the GRM is 10. You would compare this to other properties in the area to see how they fare against those. While these may be a good rule of thumb, they don't show a true picture. Different properties can have different expenses, and GRM does not account for those differences. So you may end up making a decision based on an incomplete analysis.

As noted above, you are the only one who can truly determine how good an investment deal you will get when you buy property. Always be conservative in your estimates of rents and expenses because rarely does a property financially perform as well as the original investors estimated or penciled out.

I'd opine that cash-on-cash return is your best bet. If the near-term financials look good, and you manage the property well and do the proper due diligence before and during your ownership, the future will hopefully be bright. And hopefully filled with more and more future positive cash flows that you can take to the bank!

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