Gross Rent Multipliers, Cash on Cash, Capitalization Rates, Equity Return Rates, Internal Rates of Returns, Financial Management Rates of Return - we use them all. Is this investment better than that investment? What is the maximum price I should pay? The investment may be a good one, but does it satisfy my individual goals? Where do I begin?

If we are looking at apartment investments, the Gross Rent Multiplier (GRM) is an OK place to begin. It does allow us to compare gross incomes to values - but that's all it does. It doesn't look at any other relevant factors: income, expenses, debt retirement, depreciation, etc.

Cash on Cash lets us measure how much return we are getting on our investment - but only in terms of cash flow and only in terms of our original investment. It ignores equity growth.

Capitalization Rates (Cap Rates) are swell if we want to look at our Net Operating Income (NOI) in relationship to Value; a key ratio to be sure, but does it allow us to forecast future profits? Certainly not. Cap Rates are only a snapshot of the investment at the time of purchase.

The Equity Return Rate (ERR) is helpful because it keeps us in touch with our deflating returns as our equity inflates, but does it tell me if this is the investment for me? Hardly.

The Internal Rate of Return (IRR) and the Financial Management Rate of Return (FMRR) both have their dutiful and immensely helpful place in assisting us in getting a handle on the return of our investment, the return on our investment, the current and future effects of expenses, financing, inflation, etc. Very impressive, to be sure, but I want to know if I should buy this apartment building or that retail center. I want to know if, with my individual financial demands on my particular financial assets and capabilities, I would be better off buying this self-storage facility or that office building.

I want to be able to compare, based upon my set of assumptions and projections, which purchase would be the best for me, not for Dan or Brewster but for me. I want to know that regardless of the choices presented to me, which investment will satisfy my particular parameters. What will get me to retirement on time, will meet my immediate financial obligations, will carry me through this depression, that recession, this inflationary

bubble, and that deflationary tar pit. In short, I want to know what rate I need to achieve my goals irrespective of the particular investment.

The answer is my creation, the "Your Rate". I want to personalize the rate to fit you. We could call it the Jones Rate, or the Wagner Rate or the Rumsfeld Rate. You put your last name in front of Rate, and there you have it. This rate of return that you must achieve in order to get you where you want to go by the time you need to get there. Let's build one as an example.

The procedure for calculating Your Rate is simple enough. For example, let's use Roger Davis's financial situation and goals. Roger just turned fifty and decided it was time to get serious about having money for retirement at 65. For Roger that means having an annual income equal to $100,000 today. Roger has saved $200,000 to use as seed money and he and his wife have determined that they can invest an additional $10,000 the first year and increase their yearly investment by 10% every year. (For the sake of brevity and clarity, in this example we will ignore the equity the Davis' have in their home, the IRAs that they have been more or less attentive to the past ten years and the money they expect to inherit from their parents.)

Simplified Steps for Roger
To Calculate His "Davis Rate"

Step 1: The first step is to determine the annual income needed at retirement.

a.       Age at Retirement  65
          Less Age now       - 50
          Investment Years    15  

In the T-bar which follows in item 1c, this total becomes the years.

b. Roger has determined that he would like to retire on the equivalent of $100,000 today. This dollar amount becomes the initial base for the calculation.

c. What will the inflation rate average over this period of time, 2%, 3%, 5%? This cost-of-living increase becomes the rate. Roger chose 3%.

Or, for easy figuring, $160,000.

2. Roger feels that upon retirement he can expect to obtain an annuity bearing an interest of 6%. Therefore, he calculates ($160,000 / 6% = $2,666,667) that in 15 years he will need about $2,700,000 to secure his retirement. This sum becomes the future value in the final calculation.

3. Roger's savings of $200,000 can be used as the initial investment. His contribution of $10,000, that will increase annually compounding at 10%, can be added yearly during the investment period.

(These are all negative entries as they are being subtracted from his pocket to be invested. They are cash outflows. The resultant $2,700,000 is positive because it will be a cash inflow.)

When we solve this equation, we learn that the annual compounded rate we need to achieve to reach $2,700,000 with a $200,000 initial investment and the above annual cash investments over 15 years is 14.75%. Upon attaining the $2,700,000, Davis can

then invest it in a secure, no-hassle investment that has a 6% annual yield and be sure that he will receive his desired $160,000 yearly income that roughly equates to $100,000 income today.

The needed return of 14.75% is the Davis Rate. Every time Roger analyzes an investment, he can make a determination if the investment might work for him simply by checking the investment's IRR. If, based upon Roger's financial analysis of the investment and not the seller's, the property's return is anticipated to be less than the Davis Rate, Roger must keep shopping.

The Davis Rate, Your Rate, can be instrumental in making suitable acquisitions. Used in conjunction with a Sensitivity Analysis, you can determine the exact price that is the top price you should pay for the investment you are considering. It is, of course, the purchase price that results in an IRR equal to Your Rate, which in Roger's case, is 14.75%.

This is because a Sensitivity Analysis, based upon the assumptions you and your investment broker, such as myself, have created reveal the returns that result from acquisitions at various prices. This is an excellent tool that should be consulted for every acquisition.

The moral of the Your Rate story is to calculate Your Rate now again every year until you reach your financial goal. Certainly, every time an acquisition is considered, or even when assessing your investment options, you should calculate your Your Rate. It's an invaluable tool that will guide you to investment success.

(This article was written by Mike Hesse. You may find more of his articles, his current listings and other real estate investment information at www.MikeHesse.com.)