Re: Loan constant - Posted by Dave T

Posted by Dave T on October 24, 2001 at 16:59:48:

I have never heard of a loan constant being used to determine the value of the property being purchased. Years ago, the rule of thumb for a single family residence loan was that the loan amount should not exceed 2.5 times the borrower’s gross annual income. This is the only frame of reference I have for a “loan constant”, and even this determinant has not been used in quite a few years.

While not a “loan constant”, there is a table of multipliers that lets you compute the monthly mortgage payment (PI) for a given loan term and fixed interest rate. Using the tables, you look up the multiplier for the interest rate you want and the loan term you want. Next you divide your loan amount by 1000, then multiply the quotient by the loan multiplier to estimate your monthly mortgage payment.

Neither of these gives you an estimate of the value of the property you wish to purchase. Could you, instead, be thinking about the CAPITALIZATION RATE, or perhaps even, the GROSS RENT MULTIPLIER?

Both may be used as estimators of the value of a property, in the absence of comparable values. For example, if the Gross Rents are $60000 per year, and you set your Gross Rent Multiplier at 6, then you would not want to pay more that $360000 for the property. If you have information that comparable multiunit properties in the area have a Gross Rent Multiplier of only 5, then you may say that the property you are considering is not worth more than $300000.

Capitalization Rate is the ratio of Net Operating Income to the Purchase Price (Value). Let’s say that you can get the annual income and expense reports for the last couple of years. You can subtract the annual operating expenses from the actual annual rental income to compute the Net Operating Income (NOI).

Now with the NOI, you can determine the value of the property to you based upon the capitalization rate you need to make the purchase acceptable to you. Let’s say that you want a 10% capitalization rate. This means that the NOI divided by the value of the property (expressed as a percentage) equals 10%. Let’s say that the NOI for the property was $28350 last year. Now a little arithmetic, tells you that a capitalization rate of 10% means that the value of this property (to you) is no more than $283500.

Hope this helps.