Have you ever had a tough time deciding which property to invest your money on? Well, using the gross rent multiplier (GRM) might exactly be what you need.
When you are faced with many real estate property options and it all seems very profitable, decision-making is difficult and overwhelming.
Investing in properties can be daunting, especially if you are new to the world of real estate. Because much like the stock market, real estate can escalate and depreciate in a snap.
Thankfully, the gross rent multiplier makes it easier.
How (GRM) Gross Rent Multiplier Can Help You
GRM is a tool used by real estate investors to assess and rank potential properties based on rental income and its fair market value.
Put simply, the gross rent multiplier is an easy, back-of-the-hand method to determine whether a property is income-producing or not and to see how it compares to other real estates within the area.
Gross Rent Multiplier Defined
The gross rent multiplier (GRM) is the ratio of the real estate investment in proportion with the gross rental income.
By just looking at the property price and gross rental income, investors can easily tell which of the real estates are worth your time and resources.
A good example would be the apartments and rental properties in Manhattan, New York, and Columbus, Ohio. If you were given the opportunity to invest between the two, the immediate answer would often, if not always, be New York.
Right? This is a no-brainer.
NYC. It is the big apple.
But that’s where you’re mistaken.
As of right now, Ohio is the better option because:
- Since the beginning of 2021, Ohio has been experiencing a surge in its real estate market with investment properties being snatched up by investors here and there. Roofstock reported a strong rental market in the area.
- Based on the cities’ gross rent multiplier, Manhattan averages a 16.6 GRM, while Columbus with a 10.53 GRM.
When it comes to using GRM to evaluate properties, the lower GRM the better.
A lower value indicates there is a shorter time for your investment to pay itself off, which means you can start earning rent income from your rental property sooner.
How to Calculate the Gross Rent Multiplier
Calculating for GRM is quick and easy. There’s no need to do all the complicated maths.
You only need these two things to calculate the gross rent multiplier: (1) the property price or the purchase price, and (2) the annual rental income.
Gross Rent Multiplier (GRM) = Price (PP) ÷ Gross Annual Rental Income
- $715,000 Gross Rent Multiplier Property Price ÷ $60,000 Gross Annual Rent = 11.9 GRM
*The numbers are based on the average property price gross of real estate investments in NYC.
The property price is the fair market value of the real estate, while the gross rental income is the total amount or profit received from rent.
Usually, a property’s price is based on the selling or asking price of an investment property.
Other terms for it include: sale price, list price, and appraisal value. Or you can opt to ask a real estate investor for an expert opinion.
The gross rent multiplier formula is simple—divide property price by the annual rent.
The quotient is your GRM.
Why Does It Matter?
Now that we know how to calculate GRM, the next question is what do the numbers mean?
The gross rental multiplier formula results give an estimate of how long it takes for the property to pay off the gross rent from the investment.
In the example that was given above, the GRM was 11.9. This meant that the payoff period of an average rental property in New York City would be at least 12 years.
In this way, GRM is a useful screening tool when comparing many potential investment properties.
However, it does have its limits.
Because the annual gross rent is used in the equation, the GRM formula does not account for the expenses and the operating costs that come with the real estate property purchase.
These added costs come in the form of operating expenses, maintenance costs, and property taxes per year.
The GRM is merely a simplified calculation that helps analyze a property’s value. That said, it’s still useful.
One of the first things real estate investors look at when choosing between multiple properties is the gross rent multiplier or GRM.
The formula can easily show which investment properties are a good investment or bad investment.
Keep in mind it’s not meant for an in-depth analysis of a rental property value, but rather the GRM is a starting point.
If things are still unclear, simply think of it this way: the gross rental multiplier gives you a first look, an overview, of what you are to expect.
What Is a Good Gross Rent Multiplier?
Investing in the real estate market is a long-term investment. That’s why it helps to know what is a good gross rent multiplier.
Typically, investors and real estate specialists would say that a GRM between 4 to 7 are considered to be ‘healthy.’
Anything above would mean having a more difficult time paying off the property price gross with the annual gross annual income of the rent.
In general, this is true, but the value also depends on the location, the local market, and the comparable investment properties. Including other factors such as repair costs and operating expenses.
To illustrate, bigger cities with high standards of living are found to have a larger GRM. This is due to the expensive cost of rent and investment property in the area.
In San Francisco, the median GRM is at 26.06. A value that is nearly thrice as much as the standard 4-7 GRM. Meanwhile, in Pennsylvania, the GRM is only at 10.63. (Learn more about it here).
Using GRM to Estimate Real Property Value
Besides being a screen meter for potential real estate investments, the gross rent multiplier formula can also be used in estimating the real property value.
When the fair market value or the rent multiplier property price is unknown, the GRM formula can be used to find it:
Property Price/ Real Property Value = Gross Annual Rental Income X GRM
This tells us how much an investment property is valued in the commercial real estate market.
Using GRM to Compute for Annual Gross Rent
The gross rent multiplier also comes in handy when calculating the expected rent of an investment property:
Annual Gross Income from Rent = Multiplier Property Price Gross ÷ GRM
For instance, if a real estate property is priced at $550,000 and the average GRM of the area is at 4, then expect a gross rent of $137, 500 in one year. Per month, your rental income from the property should at least be $11,458.
If the gross income exceeds the calculation, then it’s likely to be worth your money’s while.
The Pros & Cons of the GRM
As a property valuation tool, the gross rent multiplier has both its advantages and disadvantages. Knowing this can help you decide where GRM is most useful for, when to look for it, and what the calculation means.
Take note GRM is only one among the many tools in the box.
In terms of reliability, the gross rent multiplier formula is pretty much foolproof.
Real estate investors frequently rely on the GRM to compare properties, and these are the reasons why you should also be doing it:
- Unique to Rental Properties. Unlike other property valuation methods that make use of property price gross annual and price per square foot, gross rent multipliers consider the rental income, cash flow, and rent roll to be generated. This makes it easier to calculate the rate of return for an investment property.
- An Easy-No-Brainer Formula. It only takes five minutes or less to compute for the GRM.
- Benchmarks Multiple Properties. When looking into comparable properties in an area, the gross rent multiplier comes in handy. It makes the work of a property investor easier by identifying which rental properties are a good investment.
- Versatile. Regardless if you are a buyer or a seller, GRM is useful. A seller planning to put his property up for rent might utilize the equation to price his property, while a frugal buyer can search for GRMs that are lower in the market to save money.
While it poses many benefits, there are also downsides in using the gross rental multiplier, such as:
- Costs are Not Factored In. The GRM formula is an income approach to property valuation. The operating expenses, repair and maintenance costs, and property taxes are all deducted from the total profit. This might seem like it’s not a huge deal, but it actually is. It’s pointless to invest your resources in a rental property that has a relatively low GRM, but expenses to maintain it are very costly.
- Not as Accurate. Because the gross rent multiplier does not consider insurance costs, vacancy rates, and other extra fees, it does not completely capture the property’s full potential. This is why GRMs are commonly used for initial screening only. The calculation is best complimented by a further in-depth analysis of a real estate property.
GRM Vs. Capitalization Rate
A property valuation method and term closely associated with the gross rent multiplier is the capitalization rate.
The capitalization rate, or the cap rate, in short, is used in analyzing a real estate and determining its profitability and cash flow. Like the GRM, its value is based on the rental income a property can generate.
But the similarities stop there.
One of the main differences between the capitalization rate and the gross rent multiplier is the cap rate actually accounts for the property’s operational expenses and vacancy rates. Its formula includes the net operating income NOI and the price gross annual market value:
Cap Rate = (Net Operating Income NOI ÷ Fair Market Value) x 100
The product of the equation represents a more accurate and reliable calculation of a rental property.
If this is more accurate, then why bother with the GRM?
I bet you are thinking this.
To answer, the cap rate has its drawbacks. The reason why most investors use the GRM instead of the cap rate is that computing and finding a property’s operating expenses is difficult and time-consuming.
Investors opt for the GRM because it is the fastest and easiest way. In the real estate market, quick decision-making is crucial.
This leads us to the question, which method should we use: cap rate or GRM?
Either one or both. It depends on you.
If you want a more rounded perspective, computing for GRM along with the cap rate does the job. The cap rate compliments what’s lacking in the gross rent multiplier.
However, if you do not have enough time, then GRM itself will do.
Remember, GRM represents the pay-off period of an investment property, whereas the cap rate indicates whether the property has the ability to pay off its mortgage.
Other Ways to Calculate Property
There is not one single metric when dealing with investment properties. Both GRM and the cap rate, have their pros and cons.
As an investor, one should always be equipped with the right tools and equipment. In this section, we’ll be tackling two ways to calculate properties. So, keep scrolling!
Gross Income Multiplier (GIM)
Another easy way of appraising an investment or commercial properties is the gross income multiplier (GIM). GIM is the ratio of the property value to the gross income per year.
In essence, the term, GIM, is almost alike with GRM, only that this formula incorporates other non-rental sources of income and cash flow per month (i.e. vending machines, laundry shops, etc.)
Home Value Index
To calculate the home value index, take the Market Basket of the year and divide it by the Market Basket of the base year.
The home value index tells us how the market is by looking into the changes and fluctuations among gross rent multiplier property prices.
In a Nutshell…
We use GRM to assess, rank, and compare income-producing properties. In a cart full of apples, it’s not easy to sort the good from the bad. The investment property market can sometimes be like that.
Luckily, the gross rent multiplier makes it easier. By using the multiplier property price gross of a real estate and annual rental income, we can come up with a scale. GRM tells us how long it takes to pay off the investment and start earning.
Since GRM doesn’t account for operating expenses and legal fees, it’s better complemented with capitalization rate. With due diligence, we can have more accurate information and decide on the right properties to invest in.
Drawbacks to the GRM Method
The strongest argument against using the Gross Income Multiplier (GRM) is because it is a rather crude valuation technique. Changes in interest rates (which in effect discounts the time value of money), sources or revenue (quality), deferred maintenance, property age the quality of a property manager and expenses are not explicitly considered.
The GRM is not to be used for purchasing but it can be a fantastic starting point.