Investors will sometimes use terms like GRM, cap rate, and cash on cash to describe and compare investments. Using these investment ratios in conversation makes you sound like you know what you’re talking. Each provide useful information about the investment(s) being discussed and it’s important to know exactly what that is because due to their simplicity and ease of use each provide only part of the picture.
Here are the 3 most commonly used investment performance measure to compare alternative investments:
- Gross Rent Multiplier (GRM) is the price divided by the potential gross income. GRM is used to quickly survey the market for opportunities (properties with a low price relative to market-based gross potential rent). The gross rent multiplier can also be thought of as the number of years it would take for a property to pay for itself in gross rent received. As a result, the lower the GRM the better the investment opportunity.
- Capitalization Rate (cap rate) is the net operating income divided by the price. Cap rates are the basis for establishing value in real estate appraisals and are used to compare similar properties. The lower the cap rate the higher the value of the property relative to the NOI.
- Cash on Cash is cash flow before tax divided by the initial equity investment. Cash on Cash is generally used by investors looking for properties where cash flow is paramount, however, some use it to determine if a property is undervalued, indicating instant equity in a property. It calculates the length of time required to return the initial investment and can determine the yield estimate for short-term investments with no change in value.