The cap rate and the GRM are both metrics used for analyzing an income property and determining its value and profitability.
These metrics, however, use different values in their calculation, and although both are accepted by real estate investors and real estate agents for evaluating an income property, there are some similarities and some differences between them, and they both have their own advantages and disadvantages.
So, what are the capitalization rate and the GRM value? How can they be used for evaluating an income property? How are they calculated? And what are the advantages and disadvantages of each?
Let’s find out!
Cap Rate vs. Gross Rent Multiplier (GRM)
Both the cap rate and the GRM are used to evaluate an income property and determine its value based on the amount of rental income that it can generate. The cap rate and the GRM are both used for real estate analysis by real estate investors worldwide, and they are both considered as an acceptable method for evaluating an income property.
However, there are certain advantages and disadvantages to using either of these metrics, and real estate investors should know which one to use in which situation in order to get the most accurate estimates of a property’s value.
Cap Rate
The capitalization rate value is expressed as a percentage value that measures the relationship between the NOI (net operating income) of an income property and its current market value.
The cap rate can be used to evaluate an income property and determine the percentage rate of its NOI to its value.
Using the capitalization rate value is a good method for evaluating an income property because it takes into account the property’s operational expenses as well as its vacancy rate. This means that the cap rate value will show you whether the income property has the ability to pay off its mortgage or not.
Also Read: How Is Cap Rate Used for Evaluating a Real Estate Investment?
Cap Rate Calculation
The cap rate is calculated using this simple formula:
Cap Rate = (NOI/Market Value) x 100
Naturally, in order to calculate the cap rate for an income property with accuracy and reliability, real estate investors are required to do their own research to obtain additional information about the market that they’re investing in and to compare the capitalization rate values of other properties that are similar to theirs in order to determine the optimal cap rate that they should aim for.
Additionally, the cap rate can be used to calculate and measure the property’s market value using the reverse formula:
Market Value = NOI/Cap Rate
Note: Click here to start searching for income properties with readily calculated cap rates!
Advantages and Disadvantages
The cap rate is the most commonly used metric for evaluating an income property by real estate investors, agents, appraisers, and even banks.
This is because the capitalization rate value takes into account the operating expenses and the vacancies of the income property, making it a more accurate and factual measurement of the property’s performance.
The disadvantage of using the cap rate for evaluating an income property is that it is challenging to determine the cap rate value for a sold property due to the difficulty of determining a sold property’s operating expenses.
What Is the Optimal Cap Rate?
There is no such thing as a universally accepted capitalization rate value. Each market has a different performance and will have a different acceptable level of cap rate. In some markets, a cap rate of 4% might be optimal and will result in high returns, while in other markets cap rates that are below 6% might be considered too low and not worth investing in.
Learn: What’s a Good Cap Rate for Investment Properties?
To learn more about the cap rate metric, watch our video:
Gross Rent Multiplier (GRM)
The GRM of an income property measures the ratio between the property’s gross scheduled income (GSI) and its price. It is another metric used by real estate investors to evaluate an income property and determine the amount of income that it will generate.
GRM Calculation
This is the formula used for calculating the GRM:
Gross Rent Multiplier (GRM) = Market Value/Gross Scheduled Income (GSI)
Similar to the cap rate, in order to get an accurate calculation of the GRM and use it in an efficient way, real estate investors are required to do some market research and establish the average GRM for income properties that have recently been sold in the area or the market.
You can also calculate the value of a property based on its GRM value using this formula:
Value = GSI x GRM
Advantages and Disadvantages
The biggest advantage of the GRM metric is that it is easy and quick to calculate.
The disadvantage of using the GRM for evaluating an income property, however, is that it is based on the GSI, which means that it does not take into account the income property’s vacancy rate or its operating expenses.
Same as the capitalization rate, there is no universally correct number when it comes to the GRM. Although the GRM value should usually fall somewhere between 4-12, and any value below or above that could be considered unrealistic or suspicious.
Note: Click here to find the best performing properties in your market of choice right away!
Bottom Line
Both the cap rate and the GRM are considered as acceptable methods for evaluating an income property.
The cap rate, however, is considered more reliable and accurate due to its consideration for the operating expenses and the vacancy rate of the income property, making it a more accurate assessment of the actual performance of the property.
However, this does not mean that the cap rate alone should be used for evaluating an income property, and there are a number of other metrics used to supplement the cap rate and give an even more accurate assessment of the income property’s performance, such as the cash on cash return, for example.
Related: How Mashvisor Revolutionized Cap Rate and Investment Property Analysis
Finally, if you’re interested in finding income properties anywhere in the US with readily calculated cap rate values for you to compare and analyze, head over to Mashvisor and start searching for income properties in your area of choice right away.