To begin with, the FHA rules have changed for lending. Maximum limits were raised. Add to that declining home prices. The one last item to be mentioned.

Rents.

Rents and home ownership typically have an inverse relationship. When housing markets are increasing, rental markets are decreasing. Now, the housing market has decreased which has stimulated rental rates.

Back when my first property was purchased, fourplexes had negative cashflow. Having a $900,000 mortgage with $4500 rent guarantees it. These same fourplexes today, however, have dropped to $700,000. As explained, the prices will continue to drop further.

But this doesn’t affect the rent.

Insert Investor 202 Lingo: Cap Rates.

Capitalization Rate = Net Rental Income/Purchase Price.

In normal instances, cap rates range between 8 and 12%. As a seller, the cap rate should be as low as possible. This means a higher asking price. The buyer wants the highest cap rate, or the lowest price.

The market is now forcing this to occur.

Five years ago: SoCal Cap Rates around 5% ($48,000 Income/$900,000 PP)

Current Market: SoCal Cap Rates around 7% ($48,000 Income/$700,000 PP)

Investor 202 Lingo: Gross Rent Multiplier

GRM = Purchase Price/Gross Rental Income

This is a quick, dirty calculation that predicts whether a property will have positive cashflow or not. The lower the purchase price, the higher the rental income, the lower the GRM. Ideally, every investor wants GRM of 10 or less.

Five years ago: GRM around 18. Example: $900,000 PP/$48,000 Gross Rent

Current Market: GRM around 14. Example: $700,000 pp/$48,000 Gross Rent

Summary

Admittedly, the articles written over the last few days have been mere speculation regarding certain events with are transpiring. The equivalent of cherry-picking a few stories which should prove favorable for real investors.

But the hard calculations based on a snap shot of 3 years ago compared to today, should be enough to get any investor excited. The silver lining in this rather ugly mess. Cap rates are increasing. The GRM is decreasing.

This is the criteria I’ll use to evaluate properties in the future. Not today. Definitely not tomorrow. Within the next year, these numbers should be even better.

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