Tag Archives: commercial finance

GRM, Cap Rate and IRR: When and How to Use Them

Gross Rent Multiplier (GRM), Capitalization Rate (Cap Rate) and Internal Rate of Return (IRR) are three terms you’ll often encounter in commercial real estate. By the time you finish this short article, you should have a good idea about what they are, why and when you would use them, and what their limitations are.

Internal rate of return
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The GRM is the easiest to calculate, as well as the least informative number you’ll hear when evaluating commercial real estate. If you know the asking or selling price of a property as well as the annual maximum income that can be generated from the current leases, you can calculate the GRM.

As an example, let’s take a multifamily property. Assume the asking price is $1 million. There are 20 one-bedroom units, each renting for $500 per month and 20 two-bedroom units each bringing in $650 a month. Assuming no vacancies, losses or concessions, that totals $11,300 per month, or $135,600 of potential rental income per year. Dividing the purchase price by the Gross Potential Rental Income gives you the GRM, in this case 7.37.

By itself, that number has virtually no meaning. It tells you nothing about vacancies, concessions, expenses or taxes. About the only way you could use this number is to compare it to other GRMs for similar properties in the same general area. Only if one stood out from the pack would you use this to eliminate a property from further consideration, or to follow up with additional inquiries. Most investors don’t even consider the GRM, but jump straight to the Cap Rate.

The Cap Rate uses the Net Operating Income, or NOI, as its starting place. Since the NOI reflects vacancies, losses and expenses, and also adds in other income as from an on-site laundry, it’s a much better reflection of the actual operation of the property.

The Cap Rate is used mainly when buying or selling a property. You can calculate the Cap Rate if you know the NOI and the selling or asking price. To find out what the cap rate was on a recent comparable sale, divide the NOI by the purchase price. So, if the NOI is projected to be $100,000 next year, and the sale price is $1,000,000, doing the division yields a Cap Rate of 10%. This is equivalent to putting $1,000,000 into a bank account at 10% interest and getting interest payments of $100,000 per year. Continue reading

Government-Backed Financing Entities Only Players in Multi-Family

According to the latest issue of Multifamily Executive magazine, the multi-family market is being buoyed by loans from Freddie, Fannie, and HUD-backed FHA loans. The bad news is that for buyers or developers unwilling or unable to get financing from these sources, there’s virtually no other alternative right now.

Although rumors are starting to circulate that insurance companies whose investment portfolios have improved recently might re-enter the market, it’s unclear how they would be able to compete with the GSEs. That may change depending on the continued solvency of the GSEs. Right now they have healthy multi-family loan values and their default rate is below 0.5%, in contrast to the 3.13% rate that commercial banks report. However, a recent GAO report indicates “that Fannie and Freddie stand to bleed $400 billion by the time the issue of the conservancy is resolved.” This may make it more difficult for legislators to continue supporting Fannie and Freddie in their current status.

Capmark Financial on the Ropes

Capmark Financial Group is heading towards default, as the troubled lender weighs whether to file for bankruptcy after posting a $1.6 billion loss for the second quarter.

It’s a steep fall from grace for Capmark, who originated more Freddie Mac and FHA debt than any other lender last year and has consistently been one of the industry’s most prolific financiers since spinning off from GMAC Commercial Finance in 2006.

The firm has been bleeding staff and shutting offices this year, as it struggled to pay its corporate debt, which totaled about $1.5 billion. “When they went private through the spin-off from GMAC, they took on quite a bit of debt,” says Chris Wolfe, managing director of Fitch Ratings, which, along with Moody’s, downgraded Capmark earlier this month. “And they essentially violated a covenant at the end of last year. The writing was on the wall at that point.”

Read the rest of the story here: http://ow.ly/qmym