This is my first post in a series that covers investment formulas. It will cover what I consider the most important formula for single family investment real estate – the mGRM.
When buying investment property it is important to have a plan and to always stick to it. This make it easier to resist getting carried away and paying more for a property than you should. For that reason, I always use formulas when determining the limit of my offer. Of course, your formulas should depend on your use for the property. If you will be renting the property you want to make sure cash flow will be adequate. If you will be filliping the house you need to ensure a profit margin that compensates you for the time and risk.
A well know formula formulti-family investment properties, such as apartments and commercial office buildings is the Gross Rent Multiplier (GRM), whichs starts with the yearly gross rent and then multiplies by some factor (multiplier) to get the value of the property. However, I specialize in single-family residential investment property and I prefer the Modified Gross Rent Multiplier (mGRM), also known as the Monthly Gross Rent Multiplier.
This formula uses the monthly rent before expenses and is shown below:
mGRM = Sales Price / Gross Monthly Rent
To arrive at a purcahse price I simply multiply the monthly gross rent by the multiplier to get the maximum amount I want to invest in the property.
PropertyValue = ExpectedRent * mGRM
I strive for a mGRM of 60 on my properties. However, this number may vary depending on location, appreciation potential, and other factors.
Assume the house would rent for $700 per month. I multiply this by my standard mGRM of 60 and get $42,000. This means I do not want to spend more than $42,000 for the property – including purchase price, closing cost, and repairs.
Let’s see how this works in the real world:
Assuming the above example, you are in the house for $42k and finance 100% (like the old days). Your payment will be about $400 with a 15 year amortization which is common here. Property taxes and insurance will add another $120 (on my typical house) which gives you $180 positive cash flow each month.�
With this you would make $2,160 per year, plus you would be paying down principle. Of course, you will have repairs and vacancies that eat into this profit. For me, the 60 multiplier has worked well for over 5 years.
My average rent multiplier is 54 and the lowest is 36.5. My highest is 82 but luckily I have a 30 year fixed mortgage on this property which keeps the payment low.
If you live in an area with higher property taxes, have higher vacancies, or other additional expenses you need to adjust the multiplier accordingly.
As a double-check, I will make sure that my Purchase Price works well with the Nickerson Formula.
Look for other post about investing forumlas.