If you’re using Texas Hard Money Loans toward the purchase of a rental property, understanding GRM and cap rates is essential. Though they measure slightly different things, both can help indicate what the overall profitability of the project will be.
Securing Texas Hard Money Loans may be easier than traditional financing options, but lenders are still concerned about protecting their investments. Of course, profitability matters to you as well, which is why you should be familiar with your own GRM and cap rate numbers before getting to the financing stage.
Cap rate, which is short for “capitalization rate,” is the ratio of net income generated from a property against its purchase price. Let’s say you’re purchasing a single-family home and charging the tenants $1,000 per month to rent it. Your annual gross income is $1,000 x 12 or $12,000. For the purpose of cap rate, however, you’ll need your net income, which means subtracting all fees from the initial total. This includes everything from property management through insurance and taxes. If, for example, those fees come out to $3,000 annually, your net income is $12,000 – $3,000 or $9,000. Under this example, we’ll say you paid $100,000 for the home. To calculate cap rate, you’ll use the formula $9,000 (net income) / $100,000 (purchase price) = 0.09, which is a 9% cap rate. It’s also worth noting that if you’re operating a multi-family property with other revenue sources besides rent, such as laundry facilities, a game room, or vending machines, the revenue should be added to your income and the expenses of maintaining them should be deducted with your costs.
GRM, which is short for “gross rent multiplier,” is a straightforward formula. You simply divide the sales price by the annual gross rents. Let’s use the same numbers as before; you purchase a $100,000 home and rent it for $1,000 per month or $12,000 per year. The formula is $100,000 (sales price) / $12,000 (annual gross rent) = 8.33. It will take 8.33 years for the property to pay for itself. GRM can also be used backwards. If, for example, you know a good GRM is 5, then you can calculate how much to charge for rent or how much to try to talk down the seller when you’re striking a deal.
Learn the Benefits and Pitfalls of GRM and Cap Rates
It’s important to note that there’s no universal ideal GRM or cap rate. It’s location specific and varies based upon the type of property as well as other factors. That said, cap rates can be helpful when choosing between two properties and, if you know your area’s average GRM and cap rate, you can identify if a purchase is a good deal or not. Although you won’t always be asked for these numbers when you apply for Texas Hard Money Loans, you will likely be asked to provide rental income information and details about the costs, which ultimately gets extrapolated into these figures for the purpose of evaluating the risk of the loan.
Remember: if you’re evaluating properties, your calculations are only as good as the numbers you start with.
As the old saying goes, “garbage in, garbage out.” Particularly when you’re dealing with detailed numbers like net income, you’ll need to dig deep to ensure they’re accurate. You’ll also need to have solid comps when evaluating rental income too. Double check these numbers or have someone with experience crunch them before you apply for Texas Hard Money Loans or make offers on any given property.
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Dennis Dahlberg Broker/RI/CEO
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22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave | Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.