Real estate investments are tangible assets that can lose value for many reasons. Thus, it is important that you value an investment property before buying it in order to avoid any fallouts. Successful real estate investors use various valuation methods to value an investment property and these include Gross Rent Multiplier (GRM), Capitalization Rate, Cash on Cash Return, among others. Each and every real estate valuation method analyzes the performance using different variables. For example, the cash on cash return measures the performance of the cash invested in an investment property ignoring and not accounting for a mortgage, per se. Capitalization rate, on the other hand, can be more beneficial for income generating or rental properties. This is because capitalization rate measures the rate of return on a real estate investment property based on the income that the property is expected to generate.
What about the gross rent multiplier? And what is its significance in real estate investments?
In this article, we will explain what Gross Rent Multiplier is, its significance and limitations. To give you a better idea of Gross Rent Multiplier, we will compare it to another property valuation method, capitalization rate or “cap rate.”
What Is Gross Rent Multiplier in Real Estate Investing?
Similar to other property valuation methods, Gross Rent Multiplier becomes effective when screening, valuing, and comparing investment properties. As opposed to other valuation methods, however, the Gross Rent Multiplier analyzes rental properties using only its gross income. It is the ratio of a property’s price to gross rental income. Through top-line revenue, the Gross Rent Multiplier will tell you how many months or years it takes for an investment property to pay for itself.
GRM is calculated by dividing the fair market value or asking property price by the estimated annual gross rental income. The formula is:
GRM= Price/Gross Annual Rent
Let’s take an example. Let’s assume you aim to buy a rental property for $200,000 that will produce a monthly rental income of $2,300. Before we plug the numbers into the equation, we want to calculate the annual gross income. Beware! So, $2,300*12= $27,600. Now we have all the variables necessary for our equation.
Gross Rent Multiplier = Property Price/ Gross Annual Rent = $200,000/$27,600 = 7.25.
The Gross Rent Multiplier is thus 7.25. But what does that mean? The GRM can tell you how much rent you will collect relative to property price or cost and/or how much time it will take for your investment to pay for itself through rent. In our example, the real estate investor will have an 87-month ($200,000/$2,300) payoff ratio which translates into 7.25 years. That’s the Gross Rent Multiplier!
How to Calculate Gross Rent Multiplier
So just how easy is it to actually calculate? According to the gross rent multiplier formula, it’ll take you less than five minutes.
Gross Rent Multiplier = Property Price / Gross Rental Income
Like we said, very straightforward and simple. There are only two variables included in the gross rent multiplier calculation. And they’re fairly easy to find. If you haven’t been able to determine the property price, you can use real estate comps to ballpark your building’s potential price. Gross rental income only looks at a property’s potential rent roll (expenses and vacancies are not included) and is an annual figure, not monthly.
The GRM is also known as the gross rate multiplier or gross income multiplier. These titles are used when analyzing income properties with multiple sources of revenue. So for example, in addition to rent, the property also generates income from an onsite coin laundry.
The result of the GRM calculation gives you a multiple. The final figure represents how many times larger the cost of the property is than the gross rent it will collect in a year.
How Investors Should Use GRM
There are two applications for gross rent multiplier- a screening tool and a valuation tool.
The first way to use it is in accordance with the original formula; if you know the property price and the rental rate, GRM can be a first quick value assessment tool. Because investors usually have multiple property listings on their radar, they need a quick way to determine which properties to focus on. If the GRM is too high or too low compared to recent comparable sold properties, this can indicate a problem with the property or gross over-pricing.
Another way to use gross rent multiplier is to actually determine the property’s price (market value). In this case, the value calculation would be:
Property Value= GRM x Gross Rental Income.
If you know your area or local market’s average GRM, you can use it in a property’s valuation. Here’s the gross rent multiplier by city for apartment rentals.
So the gross rent multiplier can be used as a filtering process to help you prioritize potential investments. Investors can also use it to estimate a ballpark property price. However, due to the simplicity of the GRM formula, it should not be used as a stand-alone tool. Actually, no one metric is capable of determining the value and profitability of a real estate investment. The real estate investing business just isn’t that simple. You need to use a collection of different metrics and measures to accurately determine a property’s return on investment. That’s how you get a precise analysis to make the right investment decisions.
What Is a Good Gross Rent Multiplier?
Take a second to think about the actual gross rent multiplier formula. You’re comparing the cost of the property to the revenue it’ll generate. Rationally, you would want to aim for a higher income with a lower cost. So the ideal GRM would be a low number. Typically, a good GRM is somewhere between 4 and 7. The lower the GRM, the better the value- usually.
You need to keep in mind the property’s condition. Is it in need of any renovations? Or are the operating expenses too much to handle? Maybe a cheap property that rents well won’t perform as well in the long-term. That’s why it’s crucial to properly analyze any property before buying it.
It’s also not a universal figure; meaning real estate is a local industry and GRM is dynamic because rental income and property values are dynamic. So how can you quickly and easily find the appropriate figures for your investment property analysis?
What Are the Pros and Cons of Using Gross Rent Multiplier?
Pros
- It is easy to use.
- To calculate the Gross Rent Multiplier, you need to account for gross rental income. Since rental income is market-driven, GRM makes a reliable real estate valuation method for comparing investment properties.
- It makes an effective screening tool for potential properties: this tool allows you to compare and contrast several properties within a real estate market and conclude on a property with the most promise as far as price and rent collected.
Cons
- The GRM fails to account for operating expenses. One investment property might have as high as 12 GRM, however, incurs minimal costs, while another investment property might have a GRM of 5 and has incurred costs to exceed 5% of property price. Note that older properties might sell for lower and thus have a lower GRM. However, they tend to have higher expenses. Therefore, when accounting for expenses, the number of years to pay back the property price will be higher. Because the GRM considers only the gross income, GRM fails to differentiate investment properties with lower or higher operating expenses.
- The GRM does not account for insurance nor property tax. You might have two properties with the same property price and rental income but different insurance and property tax. This means that when accounting for insurance and property tax, the amount of time to pay off property price will be higher than the GRM.
- Since the Gross Rent Multiplier uses only gross scheduled rents as opposed to net income, it fails to enumerate and calculate for vacancies. All investment properties are expected to have vacancies; in fact, poorer performing real estate investments tend to have higher vacancy rates. It is important that real estate investors differentiate between what an investment property can bring in and what it actually generates, of which GRM does not account for.
What Is the Difference Between Cap Rate and Gross Rent Multiplier?
Many real estate investors confuse cap rate and GRM. We will sort this out for you. First and foremost, the cap rate is based on the net operating income rather than the gross scheduled income as calculated in GRM. So for the cap rate equation, instead of dividing property price by top-line revenue as done in the GRM measurement, we divide net operating income (NOI) by property price. What is different in the cap rate from GRM is that cap rate takes into account most of the operating expenses including repairs, utilities, and upgrades. Some real estate investors might think that cap rate makes a better indicator of the performance of an investment property. However, note that often times expenses can be manipulated, as it might be difficult to estimate a property’s operating expenses. Therefore, we can conclude the cap rate is more difficult to verify as opposed to GRM.
To sum up, the Gross Rent Multiplier is a real estate valuation method to assist you when screening for potential investment properties. It is a good rule of thumb to help you analyze a property and select from potential real estate investments. Keep in mind that the GRM does not account for operating expenses, vacancies, and insurance and taxes. Make sure to factor these expenses in your investment property analysis. For more information about Gross Rent Multiplier or other valuation methods, visit Mashvisor. As a matter of fact, Mashvisor’s rental property calculator can help you with these calculations.
FAQs: GRM Real Estate
How Can I Use Mashvisor’s Data?
Mashvisor’s investment property calculator provides all the important data involved in a property analysis. And the best part is, real estate investors can use it to find data on any neighborhood in any city of their choosing. Our tools will give you property listings in whatever market you choose, along with their expected rental income, expenses, cash flow, cap rates, and more. So if you were having a difficult time finding the appropriate data in your area required to calculate gross rent multiplier, just use Mashvisor’s tools. You’ll find median property prices and average rental income for both traditional rentals and Airbnb rentals.
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