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.
How to Calculate Gross Rent Multiplier
Gross Rent Multiplier Method
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:
- You want to consider all the factors that will impact the property’s price, including parking, laundry, storage, and so on.
- Gross annual rent will usually appear higher than the net effective rent because the landlord might be offering a deal like one month free that results in the gross rent being spread across fewer months.
- GRM does not calculate a property’s payoff period. The only way you can do this is to use the net operating income (NOI). The NOI is the profit made from a property used to give investors dividends or pay off loans made to purchase said property.
- The GRM is generally used as a benchmark for comparing one property to another. Developers will usually look at numerous properties and become well-versed in which ones need further research and investigation.
- The GRM is a powerful tool used in property evaluation and price per square foot, price per unit, and rent per square foot.
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
What is an Acceptable Gross Rent Multiplier?
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.
Why is it Important to Know the Gross Rent Multiplier?
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.
Using GRM to Monitor Property Values
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.
Benefits of GRM
What are some of the benefits of GRM?
- One benefit of the gross rent multiplier is that it can easily compare several properties in various locations with similar traits and characteristics
- It is a formula that is easy to use and simple to calculate, even for new investors
- The gross rent multiplier useful screening tool for those who are looking at multiple properties
Disadvantages of GRM
What are some of the disadvantages of GRM?
- The gross rent multiplier does not consider the operating expenses of a property. This means that additional costs such as general repairs and maintenance will not be factored into the calculation, and this can make a property seem more valuable than it is
- The gross rent multiplier does not consider vacancy rates, property taxes, or insurance
- It is incorrectly used to measure the time it would take to pay off a building
How to Use 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
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.
- Low GRM = a property with a low GRM generally signifies that it needs major repairs (such as a new heater or cooling system)
- Average GRM = decent property that still needs updates but not as extensive. These may include a paint job and replacing appliances
- Above Average GRM = property built in the last 10 years that only needs basic maintenance and upkeep
- High GRM = new property with few issues and maintenance requirements and brand new electrical and plumbing systems
Putting GRM in Context
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.
How GRM is Used in Mortgage Underwriting
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.
Understanding Fair Market Value
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:
- The location
- The size of the property
- The property age
- The number of bedrooms and bathrooms
- The amenities, such as the pool, view, gym, outdoor space, etc.
- The condition of the property
- The essential utilities included in the rent price
- The property type
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:
- It is the price an asset would sell for on the open market if all conditions are met.
- Fair market value is not the same as market value and appraised value.
- Fair market value is often used for the real estate market and tax settings.
- Insurance companies will use fair market value to figure out payouts for claim issues.
Other Factors Relating to Property Value
GRM isn’t everything. Here are several other factors to consider when looking for a rental property.
- Job market
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.
Cap Rate vs. Gross Rent Multiplier
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.
How Do I Determine Property Value?
There are a few ways you can determine the value of your investment property.
- Use online valuation tools such as public records like property transfers, deeds of ownership, and tax assessments.
- Get a comparative market analysis
- Use the FHFA House Price Index Calculator
- Hire an appraiser to appraise your property
What is a Good GRM for a Rental 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.
What is Gross Potential Income?
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.
Can I Request the Rent Roll from the Current Property Owner?
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.
What Other Valuation Methods Should I Know About?
There are five main methods of valuation you should know about.
- Comparison Method: The comparison method is used to value the most common types of property, such as homes, offices, and warehouses. The market should be stable, and there should be multiple sales of comparable properties, meaning the same size, location, and condition.
- Profits Method: Profits method is used when comparable rental or sale properties are not available, and it is generally used for pubs, hotels, and other business properties. This method will estimate a business’s gross profits and then deduct all working expenses, excluding any rental payments.
- Residual Method: This method can be used to value property with development potential or vacant land that will be used to build investment property on. You take the gross development value minus the cost of development, including the developer’s profit. Then, the residual sum is the capital that the developer can spend on the property. This method is generally inaccurate due to the number of costs that are often difficult to determine and have a tendency of changing over time.
- Contractor’s Method: The contractor’s method can be used when the previously mentioned methods do not work. This method looks at all the costs of having a comparable property and then adjusts it to reflect the age of the subject property.
- Investment Method: Lastly, the investment method is used to determine the market value of a freehold or leasehold interest in property that has the potential to gain income in the future. It is best suited for buy-to-rent or other types of commercial properties.
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:
- Simple tool with little risk of making mistakes
- Good screening tool for investors looking at multiple properties
- Saves time and only takes a few seconds to find answers
In short, the GRM is a great tool for new and seasoned investors looking to identify properties worth investing in.