How to Calculate the Gross Rent Multiplier in Real Estate
If you’ve ever been involved in real estate, you’ve probably heard the term “Gross Rent Multiplier.” But do you know what it means? Do you know how you can use it?
The Gross Rent Multiplier is one of the many ways real estate investors do market value analysis for properties.
Although it isn’t the most precise calculation, it can be useful for a quick assessment to determine whether further analysis is needed.
The real estate rental market offers amazing opportunities for return on investment. This is why investors do an initial analysis of how fast they will recover their initial investment and start making a profit.
The Gross Rent Multiplier is one way of calculating this.
How the Gross Rent Multiplier Is Used in Real Estate Investing
When real estate investors study the best way of investing their money, they need a quick way of determining how soon a property will recover the initial investment and how much time will pass before they start making a profit.
In order to decide which properties will yield the best results in the rental market, they need to make several quick calculations in order to compile a list of properties they are interested in.
If the property shows some promise, further market studies are needed and a deeper consideration is taken regarding the advantages of purchasing that property.
This is where the Gross Rent Multiplier (GRM) comes in. The GRM is a tool that allows investors to rank potential properties fast based on their potential rental income.
It also allows investors to assess whether a property will be profitable in the quickly changing conditions of the rental market. This calculation allows investors to quickly discard properties that will not yield the desired profit in the long term.
Of course, this is only one of many methods used by real estate investors, but it is useful as a first look at the income the property can produce.
Definition of the Gross Rent Multiplier
The Gross Rent Multiplier is a calculation that compares the fair market value of a property with the gross annual rental income of said property.
Using the gross annual rental income means that the GRM uses the total rental income without accounting for property taxes, utilities, insurance, and other expenses of similar origin.
The GRM is used to compare investment properties where costs such as those incurred by a potential renter or derived from depreciation effects are expected to be the same across all the potential properties.
These costs are also the most difficult to predict, so the GRM is an alternative way of measuring investment return.
The main reasons why real estate investors use this method is because the information needed for the GRM calculation is easily obtainable (more on this later), the GRM is easy to calculate, and it saves a lot of time by quickly identifying bad investments.
That is not to say that there are no disadvantages to using this method. Here are some pros and cons of using the GRM:
Pros of the Gross Rent Multiplier:
- GRM considers the income that a property will generate, so it is more meaningful than making a comparison based on property price.
- GRM is a tool to pre-evaluate several properties and decide which would be worth further screening according to asking price and rental income.
Cons of the Gross Rent Multiplier:
- GRM does not take into consideration vacancy.
- GRM does not factor in operating expenses.
- GRM is only useful when the properties compared are of the same type and placed in the same market or neighborhood.
The Formula for the Gross Rent Multiplier
This is the formula to calculate the gross rent multiplier:
GRM = PROPERTY PRICE / GROSS ANNUAL RENTAL INCOME
So, if the property price is $600,000, and the gross annual rental income is $50,000, then the GRM is 600,000/50,000 = 12.
This calculation compares the fair market value to the gross rental income (i.e., rental income before accounting for any expenses).
The GRM will tell you how quickly you can pay off your property with the income generated by renting the property. So, in this example, it would take 12 years to pay off the property.
However, remember that this amount does not take into account any expenses that will probably arise, such as repairs, vacancy periods, insurance, and property taxes.
That is one of the drawbacks of using the gross annual rental income in the calculation.
The example we used above illustrates the most common use for the GRM formula. The formula can also be used to calculate the fair market value and gross rent.
Using the Gross Rent Multiplier to Calculate Property Price
In order to calculate the fair market value of a property, you need to know two things: what the gross rent is—or is projected to be—and the GRM for similar properties in the same market.
So, in this way:
Property price = GRM x gross annual rental income
Using GRM to determine gross rent
For this calculation, you need to know the GRM for similar properties in the same market and the property price.
- GRM = fair market value / gross annual rental income
- Gross annual rental income = fair market value / GRM
How Do You Calculate the Gross Rent Multiplier?
To calculate the Gross Rent Multiplier, we need important information like the fair market value and the gross annual rental income of that property (or, if it is vacant, the projection of what that gross annual rental income will be).
Once we have that information, we can use the formula to calculate the GRM and know how quickly the initial investment for that property will be paid off through the income generated by the rent.
When comparing many properties for investment purposes, it is useful to develop a grading scale that puts the GRM in your market in perspective. With a grading scale, you can balance the risks that come with certain aspects of a property, such as age and the potential maintenance expense.
This is what a GRM grading scale could look like:
- Low GRM: older properties in need of maintenance or major repairs or that will eventually have increased maintenance expenses
- Average GRM: properties that are between 10 or 20 years old and are in need of some updates
- High GRM: properties that were been built less than 10 years ago and require only routine maintenance
- Best GRM: new properties with lower maintenance needs and new appliances, plumbing, and electrical connections
What Is a Good Gross Rent Multiplier Number?
A good gross rent multiplier number will depend on many things.
For example, you might think that a low GRM is the best you can hope for, as it means that the property will be paid off quickly.
But if a property is old or in need of major repairs, that is not taken into account by the GRM. So, you would be investing in a property that will require higher maintenance expenses and will lose value quicker.
You should also consider the market where your property is located. For example, an average or low GRM is not the same in big cities and in smaller towns. What could be low for Atlanta could be much higher in a small town in Texas.
The best way to decide on a good gross rent multiplier number is to make a comparison between comparable properties that can be found in the same market or a comparable market as the one you’re studying.
How to Find Properties with a Good Gross Rent Multiplier
The definition of a good gross rent multiplier depends on the market where the properties are placed.
To find properties with good GRMs, you first need to define your market. Once you know what you should be looking at, you should find comparable properties.
By comparable properties, we mean properties that have similar characteristics to the one you are looking for: similar locations, similar age, similar upkeep and maintenance needed, similar insurance, similar property taxes, etc.
Comparable properties will give you a good idea of how your property will perform in your chosen market.
Once you’ve found comparable properties, you need to know the average GRM for those properties. The best way of determining whether the property you want has a good GRM is by comparing it to similar properties within the same market.
Conclusion
The GRM is a quick way for investors to rank their potential investments in real estate. It is easy to calculate and uses information that is not difficult to obtain.
There are some limitations to this method, but it is useful for a first look at your target market.
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