When a real estate investor is looking into potential investments, there are countless factors that need to be considered to make sure that the investment is a profitable one and not a waste of time and money. Some of the things that an investor typically considers before investing in a property include the location of the property, the value of the property, the overall market. Most importantly, the expected cash flow or profit that will sprout from this property must be considered. This is where the gross rent multiplier could become very useful.
Since one of the most important factors to an investor is profit, they must have some sort of security when investing their money. This security must ensure that they will most likely profit from this investment.
The gross rent multiplier is a tool that helps the investor in determining which investments are worthwhile and which ones they should probably skip out on.
In this guide, we will be going in-depth on what is the gross rent multiplier as well as how to utilize it. This will help you be sure that you are making the correct decision with your investment.
What is the Gross Rent Multiplier (GRM) in real estate?
The gross rent multiplier, or the GRM, is a calculation that is used by real estate investors to analyze and evaluate the potential investment opportunities they are faced with. Calculating this metric is very simple as it only requires two factors, the property value, and the expected gross rent.
To calculate it, you simply divide the value of the property by the expected gross rent. This yields the GRM which, if all other factors remain constant, an investor would want it to be very low.
As a rule of thumb, many investors set rules and restrictions on the gross rent multipliers for their properties. For example, if a property's GRM exceeds a certain number, say 100, the investor may rule it out automatically. This saves a lot of time for the investor as he is browsing potential investments.
The GRM can also be useful for determining how long it would take for a property to pay itself off solely on the monthly or yearly income coming from it.
The gross rent multiplier can be very useful for many investors in determining whether or not to invest in some property. However, it should not be used as a sole substitute for a more in-depth and detailed analysis of properties. The purpose of the gross rent multiplier is more to allow an investor to know if it is even worth to continue looking at the other details of the property.
Gross Rent Multiplier vs Cap Rate
The gross rent multiplier and the cap rate are somewhat similar in terms of calculating. What differentiates these figures is the way that they are calculated and what is used in the process.
One of the main differences is that it is far quicker to calculate the GRM than the cap rate. On the other hand, the cap rate is a more involved approach that uses the Net Operating Income for the estimation. The cap rate is also dependent on the current market value
In the calculation of the cap rate, the net operating income is defined as some property's income minus the costs of any expenses related to said property. Some of these expenses include, but are not limited to:
- Property Taxes
- Operating Expenses
As a general principle, the cap rate is considered to be a more accurate and reliable calculation. This is because it factors in many things that the GRM does not, and provides more details and analysis. However, just like the GRM, the cap rate should not be used as an exclusive process for calculating whether or not a property is going to generate profit or not.
Gross rent multiplier (GRM) formula
As mentioned before, the gross rent multiplier should not be used as the main method for determining the viability of the investment. The lack of many details and contributing factors makes it hard to solely rely on it for your investments. There are various other aspects that an investor should consider that are not included in this formula. These factors can completely change the profitability of the property and should always be considered.
The general formula to calculate the gross rent multiplier is:
Gross Rent Multiplier = Property Value / Gross Annual Rental Income
As seen, the process of calculating the gross rent multiplier consists of taking the price which was paid for the property and dividing it by the amount of rent that you will receive every year from said property.
From this calculation, an investor can calculate how long it would take to pay off a property from the income. It also allows the investor to keep up with changes in the real estate market.
This formula is only considered useful if all other aspects of the properties that are being compared are nearly identical. When this is the case, you can use the gross rent multiplier formula to compare the two similar properties. This could be beneficial in finalizing your decision on the properties.
How to calculate the gross rent multiplier?
With the abundance of information that can be found online, calculating the gross rent multiplier is very easy.
After a few online searches, an investor should have a good idea of a fair market value for a property in the area. They should also have an idea of the average asking price for some of the properties. It is always a good idea to use multiple properties during this process to make sure that you are getting an accurate representation of the market value in the area.
If you are unable to find this information, you can contact a real estate agent in the area. A local real estate agent or office may help you with obtaining some of these numbers.
After doing your calculations, you can use the gross rent multiplier to compare the fair market value of the property you are looking into to the properties that surround it to make sure that you are making a financially sound decision.
The gross rent multiplier can also be useful for monitoring the changes in the property value based on the gross rental income from the property.
What is a good GRM?
Although calculating the GRM is something that is pretty simple, the difficult part is determining its reliability.
Normally, an investor searches for a lower GRM, indicating a lower ratio between the property value and the annual income. This would mean, in simple terms, that the investor is getting "more bang for their buck".
The validity of this value also depends heavily on the market in which the investor is buying. Some value for a gross rent multiplier may seem like an amazing deal in some markets but may be a horrible deal in a different market. Consequently, it is very important to concentrate the bulk of your research on the market of where you are investing. This is essential to ensure that you are making the most financially sound decision possible.
Another aspect that is very important to consider is why the gross rent multiplier formula is yielding a low value. Although it may seem like a sound financial decision at first, it may not be the best choice. There could be many underlying factors that are what make the GRM be so low.
This is extremely useful if the properties that are being compared are nearly identical in every other aspect. In other cases, it may not be the most accurate representation of whether or not to invest in the property and further research would probably be beneficial. For this reason, the gross rent multiplier should only be used as the beginning of your research to pinpoint properties that may not even be worth the time to look into. This is especially important because, as many people know, time is the most important thing to a real estate investor.
As a guideline, we will provide a few examples of how to calculate the gross rent multiplier depending on the different values that are given.
For this example, we will be using the annual gross income to calculate the GRM. Let's say that there is a property that is valued at $450,000. You then determine that the monthly rent would be $3,500. The first step is to calculate the gross rental income for the year. This is done by multiplying the monthly rent by 12:
$3,500 (monthly rent) x 12 (months) = $42,000 (gross rental income)
After you have determined the gross annual income, determining the gross rent multiplier is a matter of dividing the rental property value by the number that was just found:
$450,000 (property value) / $42,000 (gross rental income) = 10.7 (GRM)
You have now found the gross rent multiplier for this certain property and may continue with your research.
For this example, we will use a slightly more complicated situation to calculate the gross rent multiplier. Let us say that there is a triplex for sale and the price for the whole property is set at $600,000. You then determine that, for each unit, the monthly rent comes out to $2,750 per month. Since this is a triplex, you must multiply the monthly rent by three:
$2,750 (monthly rent) x 3 (number of units) = $8,250 (total monthly rent)
Then, like in the last example, you must multiply this total monthly rent by 12 to determine the gross rental income:
$8,250 (total monthly rent) x 12 (months) = $99,000 (gross rental income)
After determining the gross annual rent, you must use the rental property value divided by the gross annual income to finally determine the gross rent multiplier:
$600,000 (property value) / $99,000 (gross rental income) = 6.1 (GRM)
As found, this GRM is lower than the one found in the previous example, which may be an indication of an investment that may yield more of a profit than the first property.
Gross Rent Multiplier Calculator
If you want to make the process even faster, we have provided a link to a GRM calculator to quickly and efficiently make your calculations.
For most real estate investors, the list of things that must be considered before making a big investment is never-ending. Since real estate investing requires various levels of research, time, risk, and reward, it is important to any investor to make sure that their investment is going to be a good one.
Whether you are a beginner investor or an advanced one, the gross rent multiplier is a tool that can always help save some time and alleviate a fraction of the risk involved in real estate investing.
However, it is not a tool that is going to completely resolve the work that goes into real estate investing because it is merely an estimate to help you weed out your choices.
If you want a tool that could help you with the day-to-day tasks of a real estate investor or property manager, an all-in-one property management software might be the right tool for you.
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