The Multifamily Broker Podcast
Business:Investing
Ep. 116 Good Deal or BAD Deal? Complete Cap Rate and GRM Explanation!! (Real Estate Investing)
Is it a GOOD deal or a BAD deal? In today's video I'm going to show you exactly how to underwrite a commercial real estate property from start to finish. 🏁 We're going to go over TWO of the most important factors- CAP Rate and GRM. I'm gonna tell you exactly what they mean and how to use them to your advantage so you never lose money in real estate! 💸
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Video Translation:
"...Number one is the cap rate in the most simplest terms, a cap rate or a capitalization rate is a term used to underwrite commercial real estate. So underwrite means to analyze the numbers, let's say you have a 5% cap rate property. That means that that property will bring in a 5% return. If you paid all cash for the property, if you bought a million dollar property and paid cash for it with no debt, you would get 5% return a year on cash flow. After all the expenses are paid Paid off per year. This is the rate of return if there's no debt on the property. That's the simplest definition I can give you what you really need it for is to understand what kind of property you're buying and how good it is. For example, if every property in your area are going for a 4% return here in San Diego, that's like the average in good areas. San Diego has a very low return. So if you look at everything on the market and they're somewhere around a 4% return. If you're buying a 6% cap rate, you're doing really well. And this is how you calculate it. It's very easy cap rate equals the net operating income. The net operating income means that it's your gross revenue per year. So it's your gross rental income per year minus your yearly expenses. What's really important to note about this? A lot of people get this wrong is they'll put the gross rent here and divide it by the price. That's not correct at all and it will give you a false return on your value. You want to do the NOI divided by your purchase price times 100 we'll give you your cap rate. So for example, if you have an NOI of $50,000 per year, divided by a purchase price of $1 million times 100 will give you a 5% cap.
The way you can actually turn this around and get the price is, you can use the income. So $50,000 a year divided by .05 because that's a 5% cap rate and that'll give you a price of $1 million. So you can turn that equation around to do the other way to where let's say you find a property on the market and you want to know what it's worth to you. And let's say the property is bringing in $50,000 a year, $100,000 a year. It does not matter. Let's say you don't believe in the list price and you say I want to offer on this property, but I only want to pay a 5% cap rate for it. What you can do is you can take the NY, you can divide it by the cap rate that you're looking for and that'll give you the million dollar price that I'm talking about. So this is another way you can analyze properties on your own to where the value that you want to pay for may not be the same as the price that it's listed for. I'll take it a step further..."
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