Does anybody know the correct way to calculate this ratio? I have seen two ways on the internet.
House Value $200K and monthly Rent is $900 - This is an example
1. Monthly rent 900/ 200,000 = 0.005
Ideal valuation measure for investment property is 0.7% or more while 0.5% is acceptable and below 0.5% is unacceptable (monthly gross rental income divided by the current fair market value of the property should ideally be 0.7% or higher)
2. Annual gross rent 10,800 / 200,000 = .054 What is the Ideal valuation measure for this calculation?
What you are talking about is different forms of Gross Rent Multipliers.
On an annual basis it is usually shown as V/R=GRM. In you number two example it would be 18.5. That is a horrible number by the way it should be closer to 6-7.
On a monthly basis it is normally expressed as a percentage as you show. Although it might occasionally be expressed as the price = X times rent. In your example number 1 it would be "the price is 222 time rent" This is also a horrible ratios
Ideal valuation measure for investment property is 0.7% or more while 0.5% is acceptable
I am curious where you cam up with that idea? I can't imaging buying any deal at that high of a price. it makes sense for very few investors to even buy at a price higher than 1%. If you search here you will find something called the "2% rule" where proponents say you shouldn't buy a rental unless the rent is 2% of the purchase price.
I understand you are in California and finding such deals may seem impossible. So the question to consider is "Do you buy a bad investment because no good investments are available?"
I think you are looking for Cap Rate Formula.
You take your net expenses and divide them by purchase price. Going back to your example: House Value $200K and monthly Rent is $900
10,800x.30 (approximate expanses) = 3,240 (could be higher, depending on your insurance, taxes, etc.)
10,800 - 3,240 = 7,560.00
7,560 divide by your purchase price 200,000 = 4% cap rate
anything below 7% is not a good investment.
I hope this will help.
here in New Jersey typically investors look for 10% or higher.
@John Thi Gross Rent Multipliers and Cap Rates do not identify if a property is profitable or not. They only tell you the desirability of the property or the income stream.
A 30 GRM means the property is HIGHLY desired. As far as cap rates the lower the more desirable the NOI is. If two properties have a NOI of $50 000 it may sell at a 5 cap ($1, 000, 000) but in another area the same $50, 000 NOI may sell at a 12 cap ($416, 667). The market is saying that the NOI is less desirable for market reasons and will only offer at a 12 cap.
Thanks everybody, I was listening to a podcast and I started researching this ratio when they kept talking about it. This is not my idea: I got it from the link below.
FOR your NOI do you guys include property taxes and PMI?
NOI Includes ALL expenses other than financing costs. It would be your net cash flow if you paid all cash for the investment
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