Before buying an investment property, real estate investors have to analyze it first to determine its value. Fortunately, there are numerous valuation methods to do so, one of which is the gross rent multiplier. By the end of this blog, you’ll have an understanding of what the GRM is, how to calculate it, what is a good GRM for an investment property, and more. So, without further ado, let’s jump right in!
Gross Rent Multiplier: Definition and Formula
If you’ve been in the real estate investing business for a while, then you most likely know the different metrics for calculating the return on investment such as the cap rate and cash on cash return. The gross rent multiplier is another income-producing asset valuation method that property investors should keep in mind when thinking of buying an investment property.
The GRM is simply the ratio of the purchase price of a real estate income property to its annual rental income (before deducting the different expenses and running costs like utilities, property taxes, insurance, etc.). Therefore, the formula for calculating the gross rent multiplier is:
GRM = Property Price/ Gross Annual Rental Income
For example, if you’re thinking of buying an income property with an asking price of $250,000 and it has a gross rental income of $40,000 per year, then the GRM is 6.25. What does this number mean? In simple terms, this means that the cost to purchase this investment property is 6.25 times larger than the annual gross rental income it generates.
As you can see, the gross rent multiplier is a simplistic method of analyzing rental property values. Real estate investors use it to decide whether or not an income property is worth their time and money. However, what can a real estate investor consider as a good GRM? Typically, the lower the GRM, the better because it means that your rental property will take less time to pay off its price. A real estate investor should aim to have a gross rent multiplier in the range of 4 to 7.
Uses of the Gross Rent Multiplier in Real Estate
1) Valuation tool
As mentioned, the main use of the GRM is to help buyers quickly assess the value of rental properties. Property investors can use the GRM of a property similar to theirs to calculate its potential price by turning the formula around (property price = gross rental income x gross rent multiplier). This will help you evaluate whether the listing price of the property you want to buy is in line with the real estate market prices.
Knowing the gross rent multiplier of a real estate market can help you also calculate your potential rental income by turning the original formula again (gross rental income = property price/ gross rent multiplier). Say you know the local market’s GRM and property prices, but don’t have gross rent figures. In this case, you can use this variation to get an idea of them.
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2) Screening tool
If you’re considering multiple investment properties, you can use the gross rent multiplier to prioritize these properties based on their values. Performing a rental property analysis for every single property you’re considering will take so much of your time and energy. Thus, instead of wasting this time and energy on a property not worthwhile, find out the GRM of these properties and decide which ones to forget about and which ones to keep under consideration. After that, conduct a thorough analysis only on the valuable ones (that have a low GRM).
Keep in mind, however, the gross rent multiplier is not the most accurate or precise tool to compare properties. Remember to compare the GRM of the property with that of the real estate market you’re in. Additionally, don’t choose the GRM over conducting a comparative market analysis! An important step of buying an investment property is to analyze its performance regarding cash flow, cash on cash return, and cap rate in relation to other similar properties that were sold recently in the same area or location – which is exactly what a comparative market analysis does.
Limitations of the Gross Rent Multiplier
While the gross rent multiplier might be an effective tool when it comes to valuing an income property, it doesn’t show a real estate investor the whole picture. Remember, GRM only takes into account gross rents and doesn’t account for vacancies, operating expenses, or property tax and insurance, which could vary drastically from one property to another.
For example, an older rental property might sell for a lower price and thus will have a low GRM. Nonetheless, these properties tend to have higher operating expenses. Without taking these expenses into account, a real estate investor will fail to realize that it could take a longer time to pay back the price of this property than another one with a GRM of 12 that incurs minimal operating costs.
As a result, property investors need to use other valuation methods alongside the gross rent multiplier to ensure an accurate analysis and make the right investment decision. A rental property calculator will come in handy here to do these calculations!
The Bottom Line
To sum up, the gross rent multiplier is a quick valuation method of investment properties as investors can screen them and determine which one is worth their time and money. However, this is not the ultimate tool as it has some limitations. Thus, don’t neglect your job as a real estate investor and do your due diligence and analysis before making any investment decision. To get your hands on the best rental property calculator and start analyzing rental properties in any city and neighborhood in the US housing market, sign up for Mashvisor!
To learn more about how our tools help property investors make faster and smarter real estate investment decisions, click here.