Before conducting a full investment property analysis, you should consider finding the gross rent multiplier. It’s the quick and easy indicator of a potential investment property.
If you’ve been in the game for a while, you’ve probably heard tons about return on investment (ROI) metrics like the cap rate or cash on cash return. However, there’s another metric you should be looking at. The gross rent multiplier. It isn’t the most precise tool for finding the value of an investment property, but it could be used as a quick screening tool. It’ll let you know whether or not this is a rental property worth more thorough analysis.
Gross Rent Multiplier: What is it?
The gross rent multiplier (GRM) is a measure used to evaluate income-producing properties. You were probably able to figure that out from the ‘rent’ part of its name. The basic definition of gross rent multiplier is: comparing the cost of the property (price) to the annual gross revenue collected from rent (gross rental income). Notice the repetition of the word ‘gross’. It’s important when it comes to differentiating between net rental income and gross rental income. Gross rental income is the total rental income before rental expenses (insurance, repairs, property tax, etc.) are deducted. With that being said, the formula for GRM is as follows:
Gross Rent Multiplier = Property Price/ Gross Rental Income
From the name, you can come to understand that the answer derived from this calculation is a multiple. This multiple represents how many times the price of the property is larger than the annual gross rent collected. Let’s consider this example to get a better idea of what GRM really means; assume a rental property is on the market and costs $200,000. The property generates $2,500 in monthly rent. Here’s how to find the gross rent multiplier:
Property price= $200,000
Annual gross rental income= $2,500 x 12 months= $30,000
GRM= $200,000 / $30,000 = 6.67
What Does This Mean?
This means that the cost to purchase this investment property is 6.67 times larger than the annual gross rental income it generates. What does that mean for you as a real estate investor? Is it a good or bad number? Well, typically the smaller the multiplier, the better. If the gross rent multiplier is over 12, it’s considered a bad real estate investment. Usually, a GRM below 10 is better because this means the property is expected to have a higher rate of return on investment. A lower GRM is good because it either means a lower cost of property, or a higher rental income.
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Gross Rent Multiplier: What are its uses?
It’s important to note that the GRM is not to be used as an appraisal tool. Rather it could have the following uses:
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Screening tool:
In real estate investing, you’re usually considering multiple different properties at the same time. You can use the gross rent multiplier to quickly prioritize the investment properties under consideration. This quick value assessment will allow you to spend your time wisely by only conducting a detailed and thorough analysis of valuable properties. After all, you don’t want to skip this step and end up wasting time and energy on a property not worthwhile. But remember, it’s not the most precise tool to use. Compare a property’s GRM to that typically expected from the market you’re in to make sure you’re not missing a good investment. In short, the GRM can help you decide to either reject a candidate property or keep one under consideration.
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Negotiating tool:
If the property price and rental income are known, you can use the GRM to compare and contrast it against similar investment properties. If similar rental properties have the same price but different incomes, you can understand the extent of how different their values are. Sometimes, the GRM is referred to as the GIM- gross income multiplier, when it involves different non-rental income sources. Like we said, it isn’t an appraisal tool but can be used to back the reasoning behind an offer made.
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Valuation tool:
Using a GRM of a similar property recently sold, you can either use it to estimate property price or rental income. Knowing the typical GRM of the real estate market can help you calculate the potential price for a rental property. Turning the formula around, potential property price= gross rental income x gross rent multiplier. You can use this formula to see whether the listed price of investment properties in the same market is in line with what’s expected.
Another variation of the original formula can help us estimate expected rents: gross rental income= property price/ gross rent multiplier. If you know the local market GRM and are given the property price, but don’t have gross rent figures, you can use this variation to get an idea of them. All in all, using the GRM formula is quite simple, whether it’s in its original form or a variation.
The GRM is great for a buyer trying to quickly assess the value of investment properties. But sellers can also benefit from it. Since any changes in property price or rent income change the GRM, it could either favor the buyer or the seller. As a seller, you’d want to see a higher change in GRM because this could mean a higher selling price for your property.
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Real Estate Mortgages:
How does the GRM of a real estate property affect the lending criteria for it? Lending criteria for a mortgage on an investment property is a bit more difficult than that of a residential property. This is due to the risk associated with rental properties, such as the inability to meet mortgage payments due to issues with collecting rent, the fluctuating real estate market, etc. The mortgage type taken out on an investment property and the financing method could make or break an investment.
Bottom Line: How important is GRM really?
You could probably still make a great investment without finding the gross rent multiplier of an investment property. However, the importance of GRM comes into play when you need to quickly assess a property’s value. Whether you’re basing your decision on the GRM, potential property price, or rental income, you can save a lot of time. Most successful real estate investors know the value of time when it comes to making money in real estate. Any variation of this calculation can help you rank a property based on its value in comparison to similar investment properties.
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