The quest for the perfect investment property is a long journey, filled with Loopnet listings, calls to brokers, and a whole lot of pounding the pavement and property visits. To become a better commercial real estate investor, it is imperative that you streamline your process wherever possible. You can use formulas like the Gross Rent Multiplier to weed out properties that don’t fit your needs while maximizing the value you get from the sweat equity you expend in your search.
Why use the GRM formula?
The prime advantage of the Gross Rent Multiplier is speed. This calculation allows investors to use a quick, off the cuff calculation to rank possible investment properties via their rental income. It provides a lightning-quick snapshot as to whether a rental property will be a profitable acquisition, which can be particularly useful in areas with fast-changing market conditions.
What is Gross Rent Multiplier?
The Gross Rent Multiplier, or GRM, compares the total or “gross” annual rental income of a property to its fair market value. When using the GRM, you are not taking into account ongoing property expenses or monthly debt service costs. The use of GRM falls under the “income approach” where investors can quickly determine the gross rent multiplier of several properties to get a feel for their value without a deep-dive into the data.
Keep in mind that the GRM is not a replacement for a substantive analysis of a property. Rather, it allows investors to get a quick look at the numbers and acts as a signal as to whether or not that property may be worth further consideration as an investment asset.
The formula to calculate the Gross Rent Multiplier is as follows:
Property Price/ Total (Gross) Annual Rental Income
For example:
$500,000 property price/$54,000 Gross Yearly Rental Income= a GRM of 9.26.
This calculation divides the asking price for the property or its fair market value by the gross rental income for the year. It shows how long it will take an investment in the property to be completely paid off using the proceeds from the gross rent generated by the property if there were no operating or finance expenses.
In the above example, that period is a little more than nine years. Remember that the GRM does not take into account other expenses and costs of renting a property, like losses from vacancies, property taxes, insurance, and repairs and maintenance, so it is very much a back of the envelope number.
Now you know the GRM formula. But what is a good Gross Rent Multiplier? Find out here.
How to Determine Fair Market Value with GRM Formula
You can also use the Gross Rent Multiplier to determine a property’s fair market value relative to other properties. To do this, you need to determine the GRM of comparable properties within the same market/geographic location as well as the gross rent for that property. If you are assessing a new property, you can use projected gross rents.
Remember that the GRM = Property Price / Gross Yearly Rental Income
To calculate the property price, use the following equation:
Property Price = Gross Yearly Rental Income x Gross Rent Multiplier
For Example:
$54,000 Gross Annual Rent Income x 9.26 GRM = 500,040 (round down to 500k)
By using this equation, you come to a fair market value for the property of roughly $500,000.
Related: How to Value Real Estate
How to Calculate Gross Rent with GRM Formula
We will now review how you can use the formula for GRM to calculate what the annual gross rent should be. To accomplish this, you have to have the fair market value we found earlier, as well as the GRM of comparable properties within the same market.
Remember that the
Gross Rent Multiplier= Property Price/ Gross Yearly Rental Income
and that the
Gross Yearly Rental Income= Property Price/Gross Rent Multiplier
When we insert the numbers from earlier we get this equation:
$500,000 Property Price/ 9.26 GRM =
a Gross Rent of $53,995 for the year, which we can round up to $54,000.
Conclusion
Using the Gross Rent Multiplier gives investors the ability to quickly and easily sift through and prioritize possible real estate investments. Calculating the GRM is relatively straightforward compared to other valuation methods, but it is not a perfect indicator of whether a property is a good investment or not. Without taking into account factors like ongoing expenses, it is much harder to come to a truly accurate valuation. However, as long as you use the GRM to whittle down your list of potential acquisitions, it should save you a good amount of time and effort in your search for the perfect property.
For more information regarding GRM, and other ways to evaluate potential investment properties, click here.