Anyone can invest in real estate, but the most successful ones are those who develop a knack for finding the right property at the right time to yield a profit. Of course, that is easier said than done, but we have some tools to start the search. One such tool is the gross rent multiplier (GRM), which narrows the list of potential properties to those that meet specific investor standards and preferences.
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How to Calculate the Gross Rent Multiplier
The GRM, also called the gross income multiplier, is a metric used to quickly compare and evaluate income-producing properties by analyzing the property’s income compared to its price.
To find the GRM, divide the property’s price by the expected gross rent (GRM = Purchase Price/Expected Gross Rent). Investors may use either the annual or monthly gross rent, so when comparing properties, be aware of which figure is used.
Generally, a lower GRM indicates a better investment opportunity if all other factors are equal, which means that of two nearly identical properties, the one with the lower GRM is preferable. The lower GRM indicates that a property takes in a higher ratio of rent compared to its purchase price.
Limitations and Uses of the Gross Rent Multiplier
The GRM is one of a series of tools that investors can use to analyze properties. However, much like the internal rate of return and capitalization rates, the GRM creates only one piece of the whole picture.
Some investors establish their own standards and then only consider properties with a GRM below a certain threshold. Eliminating properties above your preferred GRM is one way to generate a shortlist out of many properties quickly.
Unfortunately, relying solely on GRM may lead an unsuspecting investor into a money trap. The GRM uses gross rents rather than net operating income, meaning expenses are not taken into account. A building may have impressive rental income, but it may also come with eye-watering maintenance bills and other costs.
Similarly, GRM fails to consider the location, whether there are any critical structural issues, or even the economic outlook for the area.
The GRM calculation generally relies on the property’s list price and either current or estimated rent. While current rent at least reflects that a tenant is in the property, it will not accurately capture potential earnings if many leases are coming to an end. Of course, on the flip side, the GRM may underestimate a property ripe for quick and inexpensive improvements.
Perhaps the calculation’s most fatal flaw is that it fails to factor in the remaining economic life of a property. A brand-new property could be assigned an identical value to one that is 50 years old.
All of this reinforces the underlying premise that the GRM should not be over-relied on to decide on an investment property. Instead, it is best used for quickly ranking properties and weeding out the least desirable.
What Is a “Good” Gross Rent Multiplier
The concept of a good, fair, and poor GRM varies across real estate market sectors and by location. For example, the median GRM of 1-to-3-floor apartments built before 1980 in Bakersfield, California, is 10. However, the median GRM of a building of the same size and age in Akron, Ohio, is 5.
Ultimately, when using GRM to sort or rank properties, keep the comparisons as similar as possible. For example, isolating properties of the same size or same condition leads to more accurate comparisons. Additionally, try to research the subject area to understand better what constitutes a “good” GRM in that location.
Use GRM to Find Fair Market Value
Like all good mathematical equations, the GRM formula can be shuffled around to find other information about the property.
For example, if you can find the GRMs and cash flows of other nearby, similar properties, you can get an idea of the fair market value of the subject property. For example, if you ascertain that the average GRM of nearby comparable properties is 50 and cash flow is 50,000, that would yield a purchase price of $25 million (50 x $50,000 = $25,000,000).
Alternatively, use the GRM to calculate gross rental income. If a property is valued at $200,000 and the average GRM of similar properties in the area is 20, then the expected rental income is $10,000 ($200,000/20 = $10,000).
Final Thoughts
When using GRM in property analysis, be sure to look at other valuation methods that include expenses and debt service. In addition to the cap rate calculation, cash flow after financing and the break-even ratio can help put revenue in perspective to costs.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More.
