The real estate rental market presents incredible opportunities for investors to make some good money. However, due to the risks involved in real estate investing, success is never guaranteed. So how do you decide what rental properties to invest in? One way that savvy real estate investors reduce investment risk is by evaluating residential real estate for sale using the gross rent multiplier formula.
If you have been involved in real estate, this is probably a term you have heard a couple of times. But what does gross rent multiplier mean? What is the formula for gross rent multiplier? And how do you use the gross rent multiplier formula? These are some of the common questions asked by new real estate investors and we are going to answer them in this blog.
What Is Gross Rent Multiplier?
Gross rent multiplier (GRM) is a metric used to quickly analyze and compare the profitability of a rental property based on the ratio of the property’s price (fair market value) to its estimated gross rental income. It gives an estimate of how many years it will take for an investment property to pay for itself. However, you should keep in mind that the gross rent multiplier formula does not factor in rental property expenses like vacancies, routine maintenance, property taxes, insurance, management, and debt serve.
How Do You Calculate Gross Rent Multiplier?
Here’s the gross rent multiplier formula:
GRM = Property Price/Gross Annual Rent
For example, if the price of a rental property is $200,000 and the monthly rent is $1500, the GRM will be $200,000/$18,000 = 11.1
This means that the payback period will be 11.1 years.
What Is a Good GRM for Rental Property?
Generally, the lower the GRM, the more profitable a deal is likely to be. The lower the GRM in real estate, the shorter the estimated payback period, leading to a faster return on investment.
However, what is considered to be a good GRM range for rental property varies depending on a number of factors. The most significant determinants of this number are property location and property class. Therefore, the best way to know if an investment property has good GRM is to compare the GRMs of similar properties in the same area.
For instance, since rental property expenses aren’t included in the gross rent multiplier formula, investors should consider the potential for higher maintenance costs based on the age of the investment property. Older properties with possible deferred maintenance will need a lot of repairs and upgrades. If the property needs a lot of maintenance work, the vacancy rate may also be higher. As a result, the cash flow will be affected. This means that an older rental property with a low GRM may not necessarily be a good deal. On the other hand, brand new properties will only need basic routine maintenance. With this in mind, it’s important that you have a GRM grading scale for your real estate market to balance the risk of increasing maintenance costs due to property age.
How to Use Gross Rent Multiplier
The gross rent multiplier formula can be used in the following ways:
1. To Narrow Down Your Property Search
The main purpose of the gross rent multiplier formula is to quickly estimate the profitability of a rental property. By comparing the GRMs of similar investment properties for sale in an area, you can quickly identify those with the highest potential for profit. You can then proceed to do an in-depth investment property analysis on your selected list.
Due to the limitations of the gross rent multiplier formula, it should only be used as an early assessment tool based on easily accessible property data and not a definitive indicator of value. Calculating gross rent multiplier shouldn’t be used in place of an in-depth investment property analysis.
To make a good investment decision, you need to do a comprehensive investment property analysis. For GRM to be useful, you have to use it along with other high-level real estate metrics. Here’s where Mashvisor’s investment property calculator comes into play. Our calculator allows you to accurately calculate key real estate metrics like cash flow, cap rate, cash on cash return, and Airbnb occupancy rate in a matter of minutes.
2. To Determine the Fair Market Value
The gross rent multiplier formula can also be used for property valuation. If you know the projected gross rent of the property and the average GRM for local comps, you can use the GRM formula to estimate the value of the property.
Property Price = GRM × Gross Annual Rental Income
While this is by no means an accurate valuation of property, it provides real estate investors with a reasonable estimate for use in comparing multiple properties.
Related: How to Value an Investment Property
3. To Calculate Expected Gross Rent
If you know the fair market value of the income property as well as the GRM for comparable properties in the area, you can use the gross rent multiplier formula to calculate the expected gross rent.
Gross Annual Rental Income = Property Price/GRM
Pros & Cons of Using the Gross Rent Multiplier Formula
1. It will tell you more than the property price will
When evaluating potential real estate deals, property price simply isn’t enough to find a good deal. While the gross rent multiplier formula won’t provide the entire picture, it is more valuable since it incorporates rental income.
2. Easy to calculate
The gross rent multiplier formula is simple and uses information that is readily available. Therefore, it’s useful when you need to make quick estimations and compare the potential returns of multiple properties. It is an efficient method for evaluating investment properties and eliminating potentially bad deals.
1. Property expenses are not factored into the formula
Both the cap rate and GRM are used to analyze property value. However, unlike the cap rate formula (which uses NOI), the gross rent multiplier formula does not incorporate operating rental expenses like maintenance, vacancies, property taxes, insurance, and property management.
To determine gross rent multiplier, you only use the gross rental income, which is not very accurate in assessing how potentially lucrative a real estate deal is. In fact, two rental properties can have the same gross rent multiplier but different cap rates.
2. It’s only useful for comparing similar properties in the same location
The gross rent multiplier formula is only effective when comparing similar properties in the same real estate market. This is because rental property expenses are expected to be uniform or have insignificant differences relative to gross rental income. They are also more difficult to predict.
The Bottom Line
The gross rent multiplier formula is an easy and quick way to identify potentially lucrative rental property investments in a particular real estate market. However, there are limitations to using GRM in real estate as well. To overcome these limitations, real estate investors should use Mashvisor’s real estate investment tools to analyze rental properties for sale in the US.