With increasing regularity, I am asked a variation of the question, "Why should I buy multi-family buildings in Boulder County at a 9 or 10 GRM when I can still buy a building in (Anycity), (Anystate) at a 6 or 7 GRM?"

First, let's make sure that we are all on the same wavelength. GRM stands for Gross
Rent Multiplier. It is calculated by dividing the Potential Gross Income (PGI: the maximum annual income before deductions for vacancy, utilities, taxes, management, etc.) by the value or purchase price. The commonly practiced theory is this: if an investor is trying to determine which building to purchase and they both have an SGI of $100,000, isn't it wiser to buy the building that has a 7 GRM (It can be purchased for $700,000.) rather than the building that has a GRM or, say, 10 that can be purchased for $1,000,000? After all, why pay $1,000,000 for a $100,000 income when you can acquire the same income for $700,000?

It's a good question, one that strikes directly at the heart of investment analysis and theory. Unfortunately, it cannot be answered in a coherent sentence or even in a cleverly worded paragraph.

Before the more lengthy discussion that follows, let me just say that the reason to invest is not to buy property (or cash flows) at the lowest price. The objective is wealth accumulation or ending up with the most money in the shortest period of time with the least risk.

My father taught me the same lesson that I bet your dad taught you, "Never buy a horse without checking its teeth." A horse might look perfectly good from the exterior but have severe internal problems. With horses, an experienced (and often not so experienced) eye has the opportunity to determine the general state of health of the animal by looking at its teeth. Rotten teeth are a barometer of rotten health. This is equally true of an investment property.

or even giving a great deal of weight to this one factor, may easily lead an investor astray.

What about other external factors such as location, economic dynamics, construction, general condition, the seller's situation, demographics, obsolescence?

What about internal factors such as vacancy rates, other income, credit losses, all the expenses, net operating income (NOI), mortgage rates, depreciation, etc. These internal factors are the property's "teeth" and will help you determine the overall health and real value of your investment "horse".

We are about to get into some detail. In doing so, the danger is that we will get bogged down in minutia and lose sight of the critical point that it is far less important what you pay for a property than the extent to which you profit from its ownership. Which seems more reasonable (and valuable) to you: making your investment decision based upon a ratio of income to value, or making your decision based upon how much more money you will have in your pocket at the end of the investment than you had in the beginning? The former is a math question. The latter is an accumulation of wealth question.

If the accumulation of wealth is your investment intention then you must answer three questions prior to making your investment decision: "How much in?" "How much out?" "When?"

First, "How much am I going to need to invest in this property?" This is not a simple matter of the down payment. Certainly, the amount "in" includes your down payment and associated closing costs (your initial investment), but it also includes the money that you will need to invest to complete your investment plan. For instance, how much money are you going to need in the first year to repair the roof, put on new counter tops, paint the trim, re-carpet 20% of the units and promote the units to the local manufacturing company? How much money will you need in

continued on page 2