Real Estate Investing Property Analysis 2 — Questions and Answers
Question 1: Cap rate (capitalization rate) is calculated by:
- Purchase price ÷ rental income
- Net Operating Income ÷ Property Value (Correct answer)
- Gross rent ÷ expenses
- Mortgage payment ÷ property value
Correct answer: Net Operating Income ÷ Property Value
Cap Rate = NOI / Property Value (or purchase price).
Cap Rate = Net Operating Income / Current Market Value. Example: $50,000 NOI / $500,000 property = 10% cap rate. Higher cap rates indicate higher returns but typically more risk. Cap rates vary by market and property type.
Question 2: The 1% rule in real estate investing suggests:
- Spend 1% on repairs annually
- Monthly rent should be at least 1% of purchase price (Correct answer)
- Properties appreciate 1% monthly
- Vacancy rate should be under 1%
Correct answer: Monthly rent should be at least 1% of purchase price
The 1% rule: monthly rent ≥ 1% of purchase price for positive cash flow.
The 1% rule is a quick screening tool: if a $200,000 property rents for $2,000/month (1%), it likely generates positive cash flow. Properties exceeding 1% are generally better investments. This varies significantly by market.
Question 3: Cash-on-cash return measures:
- Total property appreciation
- Annual pre-tax cash flow relative to total cash invested (Correct answer)
- Gross rental income
- Property tax rate
Correct answer: Annual pre-tax cash flow relative to total cash invested
CoC Return = Annual Pre-Tax Cash Flow / Total Cash Invested.
Cash-on-cash return = Annual Pre-Tax Cash Flow / Total Cash Invested. If you invest $50,000 (down payment + closing costs) and earn $5,000/year cash flow, CoC return = 10%. It measures the return on your actual out-of-pocket investment.
Question 4: Net Operating Income (NOI) is calculated as:
- Gross rent - mortgage payments
- Gross income - operating expenses (excluding debt service) (Correct answer)
- Purchase price - down payment
- Total income - all expenses including mortgage
Correct answer: Gross income - operating expenses (excluding debt service)
NOI = Gross Income - Operating Expenses (does NOT include mortgage/debt service).
NOI = Gross Rental Income + Other Income - Vacancy Loss - Operating Expenses (taxes, insurance, maintenance, management, utilities). Mortgage payments are NOT included in NOI because NOI measures the property's performance regardless of financing.
Question 5: A property with a higher cap rate compared to similar properties may indicate:
- Lower risk
- Higher risk or potential problems (Correct answer)
- Better location
- Newer construction
Correct answer: Higher risk or potential problems
Higher cap rates often signal higher risk — distressed property, bad location, or deferred maintenance.
While higher cap rates mean higher initial returns, they often indicate higher risk: poor location, deferred maintenance, problem tenants, or economic uncertainty. Premium properties in desirable areas typically have lower cap rates because they're lower risk.
Question 6: The Gross Rent Multiplier (GRM) is:
- Annual rent × 12
- Property price ÷ Annual gross rent (Correct answer)
- Monthly rent ÷ expenses
- NOI × cap rate
Correct answer: Property price ÷ Annual gross rent
GRM = Property Price / Annual Gross Rental Income.
GRM = Purchase Price / Annual Gross Rent. A $300,000 property with $36,000 annual rent has a GRM of 8.3. Lower GRMs suggest better deals. GRM is a quick screening tool but doesn't account for expenses like cap rate does.
Real Estate Investing Property Analysis 2
Cap rate (capitalization rate) is calculated by: