How I use GRM, CAP, and COC

If you're confused by these measures and how to use them, don't be! 

Like all metrics, they serve their own purpose, but it's important to know what that is.

Comparison Shopping

Here CAP and GRM are your friends since they are simple equations used by everyone.

CAP
For example, in my home market, the average CAP rate is ~5.5.  If I see a listing with a 3 CAP, the list price is probably completely unreasonable, and is possibly an unmotivated owner's attempt to sell at an unreasonable price.

I also use CAP to evaluate property pre and post purchase.  If my property has a very high market CAP rate, it probably has excessive equity that should be monetized and re-invested.

GRM
In general anything with a GRM less than ~13 provides a competitive cash on cash return - which I will discuss next.  Like CAP, if I see a listing with a GRM of 18, it's probably not worth looking at.

Cash Flow Analysis

COC
I like to use cash on cash return for my personal investment analysis for two reasons:

1) When purchasing a property with up-side potential, the return on my investment in property improvements from resulting increased rental rents and lower operating costs is the most important metric.

2) COC is a great way to compare a real estate investment to other investment options such as stocks or bonds since the equation is the same: the annual cash return on the cash invested.

COC is calculated like this:

Net income before taxes / Total cash invested

For example, net income before taxes is the sum of:

• rents
• less operating expenses
• less mortgage, taxes, and insurance expenses

Net cash investment is the sum of:

• cash to close
• pre-rent improvements
• large post-rent improvements
• less any cash-out received via a re-finance

In practice, the equation looks like this:

Net income

• annual rent: $5,000
• operating expenses: $2,000
• mortgage expenses: $1,500
• TOTAL net income: $1,500
  

Quick Tip:

Cut annual rental income in half for a quick determination of average net income on an improved property. 

Cash invested

• cash to close: $20,000
• improvements: $5,000
• cash-out re-fi: $8,000
• TOTAL cash investment: $18,000

Cash on Cash Return
$1,500 / $18,000 = 0.083 (~8%)

In this way, I can quickly and easily determine the return on my investment. Clearly the number can change over time as rental income and expenses fluctuate from year to year.  So what may have been a poor investment at one time, may evolve into a high-performer, or vice versa.