Yield (Part 1)

Yield (Part 1)

There are various ways that investors measure yield. The oldest and simplest is probably the “gross rent multiplier”. This method, while very unsophisticated, is great for comparing properties that are almost alike. The purchase price is divided by the annual rent. The investor determines that the property will return the purchase price in a certain number of years. Expenses are not taken into consideration.

A similar but more sophisticated method is the “capitalization rate” or “cap rate”. In this method the net operating income is divided by the purchase price. The percentage returned is called the “capitalization rate”. The net operating income is the income from the property minus the operating expenses. Operating expenses are the expenses that are involved with the operation of the property as a rental. The mortgage payment or debt service is not considered as an operating expense. In a pure net lease the tenant pays all of the expenses. In this case the “gross rent multiplier” is as good as the “capitalization rate”. The advantage of capitalization rate is its nearly universal use and its understanding by most investors. In a property with expenses, the “capitalization rate” is superior to the gross rent multiplier.

The two methods above measure the return on the property. They do not take into consideration the investment itself. Leverage is often an important tool in any investment. To consider the return on the investment the “cash-on-cash” method is sometimes used. In this method, the cash invested is divided by the annual projected cash flow of the investment. This percentage allows comparison of two different types of property or different amounts of leverage used.

All of the methods above measure the return on an investment. None of them measure the return of the investment. To do this the sale value of the investment after a period of time has to be considered. Also there are frequently negative or uneven cash flows during the holding period. To account for these things the “Internal Rate of Return” is used. The next blog will address the “Internal Rate of Return”.



David Segrest is a REALTOR in Charlotte, NC

David S. Segrest, CIPS, CCIM, TRC, CEA
david@segrestrealty.com
http://www.segrestrealty.com
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