The world of real estate can be very complicated to navigate through for a first-time investor. However, by using the right resources and tools, you can take a well-informed approach to your investment research and eventually purchase the property that is right for you.
When looking for a property, one of the best ways to save time and energy is to find the Gross Rate Multiplier (GRM) of individual properties across neighborhoods, cities, or even states.
GRM is calculated by dividing the property’s asking price by the annual gross rental income. This is assuming that you know the property’s gross yearly rental income. If the seller does not give the actual rent price, you will need to do some digging and market research to figure out the average asking rents at properties comparable to those you are looking at.
However, it is essential to remember that the gross rent multiplier cannot be used to estimate the amount of time you will need to pay off a property. Why is this? Because other factors will affect the payoff period, such as paying expenses that reduce cash to amortize the cost of buying a building. The gross rent multiplier also does not account for the cost of credit that might have been used to purchase the property.
In simple terms, the gross rent multiplier equals the price divided by the gross annual rent.
GRM = Price / Gross Annual Rent
Here are some things to remember when calculating GRM:
The GRM can increase or decrease depending on factors such as the type of property and location. For example, the GRM is a different range for Class A properties versus Class C properties. Class A properties have a lower operational risk because they are taken care of and better located and have higher credit tenants. These factors differ from Class C properties. The GRM will be different across cities and even states, allowing investors to compare opportunities outside of areas they are familiar with. For example, if a developer finds that prices have gone up in their local market, they may want to look at markets elsewhere where the GRM is still in the single digits.
Property price: $2,000,000
Gross Rental Income: $320,000
GRM: $2,000,000 / $320,000 = 6.25
A decent GRM depends on the market and comparable properties in the area. Generally, the lower the GRM, the less time it will take for the investor to pay off the property, which means you will have more profit. It represents the number of years it would take for the property to pay for itself in gross received rent.
A good GRM is between 4 and 7. Anything above that, and you will have a hard time making a profit. Anything below that and the property likely requires many repairs and could lead to financial problems. The number depends on several factors such as maintenance, management, repair costs, and utilities.
A “good” GRM depends significantly on location. For example, if you invested in a property in San Francisco or another expensive city, you would likely have to contend with high GRMs due to the higher property costs.
When looking into commercial real estate, the investment process can be somewhat daunting. You need to quickly differentiate between properties to decide how much effort you need to invest in the property to make it profitable.
Commercial property valuations are different from residential property valuations, and many factors go into choosing a property. Property comparisons are much more difficult when you must worry about overhead cost and maintenance and dealing with factors such as rental income, tenant issues, and raises, and anything else that comes with running a solid commercial property.
The GRM allows you to quickly compare two similar properties, which may be in different locations, sizes, or unique characteristics that warrant further research using more precise comparison tools.
As a result, it is a great way to save time looking for investment properties instead of researching every property to determine its financials.
An investor can look up the Gross Rent Multiplier quickly and make decisions immediately. Time is of the essence when it comes to looking at investment properties, and the faster you can come to a well-educated solution, the better.
GRM can also be used to monitor the value of a property. According to Trion Properties, “Rather than using the purchase price and gross rents to calculate GRM, we can flip the equation to calculate value.” The formula here would be:
Property Value = GRM x Gross Annual Income.
For example, if the GRM is 8.25 and the Gross Annual Income is $400,000, the equation would be: 8.25 (GRM) x $400,000 (Gross Annual Income) = $3,400,000 (Property Value).
The investor should look at comparable sales, and use sales data and gross rent figures to figure out whether the potential value makes sense along with recent market averages. If the investor were to do the calculation and find out that their property value is not in line with the market, then it might be an indicator that the owner is charging lower prices for rent, which would result in an inaccurate GRM, and furthermore, the property calculation would be off. This is common among long-term owners who are regularly engaged in property management. Their rents will tend to dip below market rate over time.
What are some of the benefits of GRM?
What are some of the disadvantages of GRM?
It is vital that you thoroughly screen for properties even if you don’t think it is likely to fail as an investment or cause you to lose money. An investment property can mean a great deal of passive income or be a complete money pit.
Creating a GRM grading scale is a good way to prepare for unexpected property issues and maintenance expenses. A lower GRM could mean having enough income to pay off a property quicker, but investors should also pay attention to property age and high maintenance costs.
Roofstock explains why the GRM grading scale is useful and how it works in real estate. Here is what different GRM grades can mean.
There are many tools for gauging a property’s value, and GRM is one of the simpler options. All investors should consider other tools, as well, when choosing whether to purchase a property. GRM should be used as a starting point, alongside other tools such as cap rates and cash return calculations.
He is an example where a valuation tool other than GRM would be better. The gross annual income reported by a seller is skewed due to something like a renovation project. That unit’s rent may not be accurate in the rent roll shown by the seller, as it may be much higher now that the unit has been fixed. In this case, it would be best to hire a professional to appraise the property.
In commercial real estate, the bank wants to know that the rent can support the mortgage given to the buyer. In this case, the buyer’s personal credit score does not matter as much. Lenders will use GRM to analyze a property’s sale price to income ratio, and that will gauge how much credit the lender can give to the borrower.
When the property is not for sale yet, you need to guess the price to determine GRM. One way to do that is with the fair market value, which is the amount of money that a property in a specific market may sell for at a given time.
It is essential to know the fair market value before listing a vacant rental property, adjusting rent, and when choosing a rental property to buy. Several factors influence the fair market value, including:
Fair market value is often used in legal settings, such as divorce settlements, for compensation purposes. It is also used in taxation, for example, when looking for the fair market value of a property for a tax deduction.
Here are some important facts to know about fair market value:
GRM isn’t everything. Here are several other factors to consider when looking for a rental property.
You want to invest somewhere where the job market is flourishing. Many workers will flock to an area that is hiring heavily as they enjoy a close commute to their job.
2. Property taxes
Depending on where you choose to invest, property taxes may be very high. Be sure to do your research on property taxes before settling on a property.
3. Future development
While construction and future developments can be a good sign for the neighborhood, additional housing may cause competition with your property.
Check the crime rate in your neighborhood before investing in a property. No one wants to live in an unsafe area. Be sure to ask about the frequency of police presence as well.
The neighborhood you choose to rent in will determine your clientele and vacancy rate. Be sure to investigate the surrounding area and the neighborhood’s details before settling on a site.
6. Natural disasters
If an area is prone to flooding or earthquakes, you may want to reconsider. Another option is to investigate earthquake insurance or other natural disaster insurance. However, these additional costs can take away from your rental income.
If you plan on renting out to families, the school district will play a significant role in your property search. The quality of schools will determine the families you will rent out to, and if there are no good schools nearby, you may lose clientele.
8. Number of listings and vacancies
A high vacancy rate means people are leaving the area, which can be concerning for an investor looking to rent out a property there. Look for a low vacancy rate, as this will allow you to raise your rental prices.
9. Average rents
Rental income will determine how much your property will go for. Make sure your rent can cover your mortgage payments, taxes, and other expenses you may have. Research the area to see where it will be in five years. You will have a better idea of what to expect in the coming years.
What does your neighborhood have to offer? Be sure to investigate the restaurants, parks, malls, entertainment venues, and other amenities that might attract potential renters.
Investors will often confuse a cap rate with the GRM. The cap rate is based on the net operating income rather than the gross income calculated in the GRM.
When calculating the cap rate equation, instead of dividing property price by revenue, you divide the net operating income by property tax. The cap rate will factor in most operating expenses, including utilities, upgrades, and repairs.
Some real estate investors may think that the cap rate gives you a better indication of how well an investment property will do. However, it is essential to note that it can be hard to estimate a property’s operating expenses. Therefore, the cap rate is more difficult to find than the gross rent multiplier.
There are a few ways you can determine the value of your investment property.
When renting an apartment to a tenant, gross monthly rents should be equivalent to at least 1% of the purchase price. For example, a rental property that sells for $500,000 should have $5,000 in gross rent per month. A property that sells for $1,000,000 should create at least $1,000 in gross rent per month. Generally, for a rental property, a strong GRM is between 4-7.
Gross potential income is the total rental income a property can make if all the units were occupied and rented at market rates. Gross potential income is also referred to as potential gross income, possible gross rent, or gross scheduled income.
The gross potential income does not include the property’s actual rent, the vacancy rate for the area, the property type, or any debt service related to owning the property. It is the income a property could potentially produce, not what it will make for sure.
A rental roll shows the rental income from a real estate asset. It can apply to any type of income-producing property, including multi-family buildings, single-family homes, or commercial properties.
You should request a rent roll to see the property’s potential income and if the property has been consistently making money. A potential buyer will look over the rental roll as one of the determining factors of a good property investment deal. The investor will evaluate the numbers to see if there are ways to increase the value of the property.
There are five main methods of valuation you should know about.
Gross rent multiplier gives real estate investors a quick way to screen and filter out potential real estate properties. It is easy to use and requires information that may already be available to you.
To refresh, here are a few reasons why one should use the gross rent multiplier:
In short, the GRM is a great tool for new and seasoned investors looking to identify properties worth investing in.