Swimming Lessons: Terms Used to Determine Value

As an investor, it's handy to know the CAP Rate for an area because you then can reverse the equation to figure out the market value of a property. You can use this information to determine what a smart price would be to offer a seller. The equation for finding market value is:

NOI / CAP Rate = Market Value

Research groups such as PPR Research Center offer quarterly regional reports on metropolitan CAP Rates. For a fee, you can order reports for a particular city that specifically target apartment, retail, commercial, industrial, or warehouse investing. However, CAP Rates don't make sense when buying single-family residential properties. In those cases, it's better to use a comparative market analysis (CMA) to help determine the value of a property.

Cash Flow -- Cash flow is the profit that remains after annual expenses are deducted from the annual income of a property. Another term often used interchangeably with cash flow is net-spendable income, which refers to the liquid funds that are available to be spent annually based on the profitability of a property.

CMA (Comparative/Competitive Market Analysis) -- CMA reports are used throughout the real-estate industry. A comparative market analysis estimates the market value of a property by comparing it to similar properties that have sold in the area within the last six months to a year. Anything sold beyond that point is considered irrelevant due to changes in the market. CMAs can be spreadsheets that show average real-estate sales in a particular neighborhood, or they can itemize specific characteristics and adjust the sales price of each house to account for differences. Skilled real-estate agents can provide accurate CMA reports that also take into consideration closing arrangements that impact the real sales price of the house but aren't necessarily reflected in the official sale price. Considerations such as the buyer's closing costs or repair costs that were actually paid by the seller should be reflected in the sale price. For example, if a house sells for $150,000 but the seller pays $6,000 towards the buyer's closing costs and $500 in repairs, the actual price of the house is closer to $143,500. Adjusting for these factors can give a clearer picture of the CMA.

Some agents use the term CMA to mean competitive market analysis. This analysis not only takes into account the houses that have sold within a market, but also houses that are presently on the market and houses that have been listed but didn't sell.

GRM (Gross Rent Multiplier) -- GRM is a market comparison technique in which the sales price of the property is divided by its gross annual rent. The weakness of this method is that it doesn't account for expenses that the property must cover annually. It's also not a good tool to use in the single-family residential market.

NOI (Net Operating Income) -- NOI figures are useful in determining an accurate account of a property's annual cash flow. The formula for figuring NOI is gross income minus operating expenses.

Operating Expense Ratio -- After you've figured the total operating expenses of a property, you can divide it by the gross annual income of a property. The resulting number is the operating expense ration, which is expressed as a percentage. Different types of properties have typical operating ratios. With a little investigating through real-estate agents and reports provided by some research groups, you can use this ratio to see if your property measures up to comparable properties, or if a particular property would be a wise investment.

ROI (Return on Investment) -- This calculation shows anything of value that is received above the total investment made by an investor. This figure can be calculated in several different ways: Some people use the cash flow or NOI method to show profitability, some use other methods which include tax deductions for reporting loss.

Value -- This term typically refers to market value, which is the highest price a property would bring under average conditions if the seller is able to convey the title. Average conditions include that the property is bought with cash or cash equivalent, is given adequate exposure through advertising for a reasonable length of time, and that both the buyer and seller are informed and not under any adverse pressure to complete the transaction.


These terms can provide buoyancy for an informed investor. With a little investigation, you can ascertain all of this information about a prospective property and make a sound decision. Eventually, you should be able to find a tool you can use to gather this information quickly and efficiently and assimilate it into a report format that will become the measuring stick of all your investments. Whether that tool is a software package, an investment broker, a real-estate agent, or just good old pen and paper depends on your individual personality and needs. But no matter which tool you choose, the end goal is to have a reliable means of data collection and reporting that will be the most efficient use of your time and money.