Investors: Multi-Family, Mixed Use & Commercial Real Estate
Many people dream of owning real estate as an investment, and for good reason. Over the long term, real estate values appreciate and hold their value more reliably than other types of investments. Although the US economy experienced dramatic drops in real estate value during 2006-2012, the pre-recession values are being seen again, and this sector remains a very attractive place to invest for the future. Real estate investments are generally classified as either residential or commercial.
KRG agents in Greenwich and Stamford have sold hundreds of millions of dollars in commercial real estate over the past twelve years including hundreds of multifamily units, mixed-use downtown buildings, restaurants, contractor lots, warehouses, and land ready for development.
Residential Real Estate as an Investment
A residential property is a single family or multi-family dwelling with fewer than four units. Sure, not everyone is cut out to be a landlord, but for people who have patience and attention for detail, becoming a landlord is great way to reduce personal cost of living and/or build a nest egg for retirement.
A real estate agent, who is experienced with multi-family purchases as well as rentals, can help buyers to identify comparable homes or buildings, estimate the potential rent income, and determine a fair purchase price.
Once you calculate GRM for your 4-6 comparable properties, the average GRM is used to estimate a price or value for the multi-family house or mixed-use property.
GRM * = purchase price divided by the monthly rent income
GRM represents the number of months’ rent it would take to pay for the house if the buyer pays cash up front…the lower the GRM, the better. This is an oversimplification, of course, but GRM can help a buyer to determine which house might make sense to purchase, or what the target price would be for a potential purchase.
A key element in the GRM calculation is the estimate of monthly rent income.
It is important to use actual RENTED unit data, not current list prices.
Once you calculate GRM for your 4-6 comparable properties, the average GRM is used to estimate a price or value for the multifamily house or mixed-use property.
A good real estate agent is a valuable asset to buyers in helping you navigate this process.
*Note that GRM does not reflect any operating expense, property taxes, or management costs; to include those elements in your analysis, calculate a Capitalization Rate (CAP rate), which is an expression of Return on Investment (ROI) for rental properties.
Commercial Real Estate as an Investment
Any investment for which the owner receives periodic rent can be classified as a commercial property. This can include residential dwellings that are greater than four units, mixed-use buildings, office buildings, warehouses, industrial buildings, retail spaces, parking garages, land for development and agricultural land.
Each type of commercial property has its own unique operating challenges and potential Return on Investment (ROI).
Prospective buyers should consult with an experienced real estate agent to determine if this type of investment fits their goals.
Potential investors should compare the Return on Investment (ROI) with the returns they could earn by investing in something else, such as the stock market.
Ien commercial real estate, the most commonly used calculation for ROI is called the Capitalization Rate (CAP rate). An experienced real estate agent can help with the detailed analysis.
CAP Rate = Net Operating Income divided by the Property Asset Value
For example, A commercial property sells for $1,000,000 and generates an annual Net Operating Income (NOI) of $100,000, the Cap Rate would be 10%.
1. Income ÷ Rate = Value
2. Income ÷ Value = Rate
3. Value x Rate = Income
Net Operating Income ÷ Capitalization Rate = Value
$100,000 income ÷ 9% cap rate = $1,111,111
$100,000 income ÷ 8% cap rate = $1,250,000
$100,000 income ÷ 6% cap rate = $1,666,666
Net Operating Income ÷ Value = Rate
$100,000 income ÷ $1,111,111 = .09% rate
$100,000 income ÷ $1,250,000 = .08% rate
$100,000 income ÷ $1,666,666 = .06% rate
Value x Rate = Net Operating Income
$1,111,111 value x .09% rate = $100,000 income
$1,250,000 value x .08% rate = $100,000 income
$1,666,666 value x .06% rate = $100,000 income
Note the relationship between the rate and the value. As the rate goes down, the value increases. If you’re a seller; you want to sell for a 5% CAP rate, if you’re a buyer; you want to buy for a 10% CAP is rate.
Net operating income (NOI) is a calculation used to analyze real estate investments that generate income.
NOI equals all revenue (apartment rents and coin-op laundry) from the property minus all reasonably necessary operating expenses (utilities, maintenance fees, management fees, liability insurance and taxes).
Note that mortgage principal and interest are not considered operating expenses; they are debt service, and they get subtracted from NOI to determine Net Cash Flow.
Net Operating Income = Net Income – Operating Expenses
In essence, the NOI is the cash generated by the property, which would be used to pay the mortgage, fund capital improvements, and generate Net Cash Flow for owners. Remember, Net Cash Flow is the most important calculation!
Net Cash Flow = NOI – Debt Service – Capital Improvements
To estimate a fair purchase price for a rental building, first estimate the Net Operating Income the building could generate and divide that by your target CAP Rate. For example, if a building could generate a NOI of $85,000 per year, and you are looking for a CAP Rate of 10%, then your target purchase price would be $850,000.
**See our mortgage calculator to find out what your scenario looks like.