There are many ways to measure the return on your investment. Naturally, each one has its advantages and its disadvantages. Once you are familiar with them, you can choose the technique that works best for your particular situation.

Gross Rate Multiplier (GRM): This is the most commonly used measure. It is calculated by dividing the Gross Rents by the Price. It is widely used because it is quick and easy. Also, it requires very little information all of which is readily available.

However, its simplicity is also its greatest detriment because it doesn't really tell you very much. It does not allow for most of the relevant investment factors: appreciation, depreciation, operating expenses, financial leverage, mortgage amortization, income taxes or risk.

Capitalization Rate (Cap Rate): Measured by dividing the Net Operating Income by the Price, the Cap Rate is probably the most widely used investment measure by brokers and appraisers. It has the advantage of bringing the operating expense into the analysis.

On the down side, the Cap Rate does not explicitly allow for appreciation, depreciation, financial leverage, mortgage amortization, income taxes or risk.

Cash On Cash: This rate is popular because it is simple to use and its name has an appealing ring to many cash oriented investors. Being similar to a stock dividend, it is calculated by dividing the Cash Flow Before Taxes by the Initial Investment.

On the other hand, it does not consider appreciation, income taxes, mortgage amortization or risk. It also does not allow for meaningful comparisons with other investments.

Equity Return Rate (ERR): The ERR is calculated by Adding the Cash Flow After Taxes, the 1st Year's Principal Buildup and the 1st Year's Appreciation by the Initial Investment. While this is a fairly good measure of the first year of operation, it does not consider the complete holding period, and it does not allow for risk.

Internal Rate of Return (IRR): The IRR is the most commonly used measure by sophisticated investors. This is because it may be used for comparisons of all types of real estate and non-real estate investments, and because it may be used to determine an optimal investment strategy (holding period, method or acceleration, type of financing, etc.) for any type of investment.

The advantages of the IRR are that it 1) considers all relevant investment factors except risk, 2) is applied over the entire projected holding period, and 3) recognizes the time value of cash flows. However, it does 1) require "accurate" predictions of future cash flows, 2) require greater knowledge of the investment, and 3) is difficult and time consuming to calculate without a financial calculator or computer.

One value that I bring to my clients is detailed analysis of an investment or portfolio. This enables them to make better decisions prior to a purchase, sale or exchange. The result, of course, is higher returns and greater wealth accumulation. -

MIKE HESSE, CCIM, CPM
Real Estate & Investment Specialist
DIRECT - 720.581.2222
online at www.MikeHesse.com
email Mike@MikeHesse.com