Gross Rent Multiplier & Its Uses For Investors
By: ROS Team
It may be quite confusing to establish which rental property is the best investment if you start investing in real estate. Fortunately, you can use several critical economic criteria to pick which property to generate revenue is better than the others.
The gross rent multiplier is being used by both first and seasoned real estate investors to identify the best properties they may invest in and monitor the property they currently own in real-time.
We’ll discuss in this post how you can select the proper investment using the gross rent multiplier, why the metric differs from the cap rate, and how you can best use the gross rental multiplier calculation when you invest.
1) What is a GRM
2) Calculate the GRM
3) GRM vs. CR
4) Why is GRM Important
5) Benefits of GRM
6) Limitations of a GRM
What is a Gross Rent Multiplier?
A gross income multiplier is calculated by dividing a property’s sale price by the gross annual rental income. The most practical use of GRM is when determining how long it will take to earn the principal amount back.
Key Takeaway:
If the gross rent multiplier is lower, investors can expect to get their money back sooner.
Here is the GRM classification pattern:
8 to 10 – 25 years older = a quite overdue maintenance
10 to 12 – 10 and 20 years = modernizing maintenance
12 to 1 -10 years of age = new quality property, routine maintenance
14 – High rent properties under ten years of age = efficient maintenance
Analyzing GRM helps investors understand the price of a rental property compared to the income they can expect the property to bring in over time. GRM calculations are not perfect, but they are effective in helping investors choose among different potential real estate investment opportunities.
How Can We Calculate the GRM?
For the sake of our process on how to calculate gross rent multiplier, let’s assume the net value of the property is $400,000 while the expected annual rental income of the property is $50,000.
The formula to get the gross rent multiplier is
Property Price / Gross Rental Income = Gross Rent Multiplier
$400,000 ÷ $50,000 = 8
The GRM indicates that it would take approximately eight years for an investor to recoup their initial investment. It bears repeating that using the GRM is not a perfect science. There are certain limitations because the calculation does not incorporate additional expenses like real estate taxes and maintenance costs.
Gross Rent Multiplier vs. Capitalization Rate
Along with GRM, the capitalization (or cap) rate is also used to compare properties based on the amount of rent the property could generate. The cap rate uses the property’s net operating income in evaluating the comparable properties, while GRM uses gross income.
Cap rate considers elements that could impact earnings, such as the cost of repairs or renovations. It helps determine whether or not income generated by the rental property can pay off the home loan.
However, it is hard to determine the actual expenses in any situation, so the cap rate may also fall short of providing a consistently accurate analysis. Consider GRM as a first quick look method while using the cap rate as a second-tier analysis for more insight and accuracy.
What is a Good GRM?
We came up with the number 8 in our example. Understand that the GRM is likely to decrease over time since the property price increases with time. Initially, in a real estate cycle, the GRM remains high as the market emerges from recession, but soon investors will return to the market, and the GRM will go down. Therefore, a high GRM should not look unusual at the start.
Additionally, while deciding on potential investment property, investors should compare apples with apples. In other words, analyze similar properties against one another (i.e., a residential property against another residential property). An industrial property’s GRM should not be compared with a residential property’s GRM because they serve different markets.
Why is GRM Considered Important?
Real estate investment involves quick analyses of different properties to determine which has the better probability of turning a profit. Multiple factors go into the property valuation process, and property comparison becomes even more challenging when considering unknown expenses.
GRM helps investors greatly by comparing two similar properties, even different sizes, and locations. Instead of preparing the financial feasibility of every single building an investor looks to invest in, they can quickly calculate the GRM and get a better understanding of whether or not to invest. You must clearly understand how to determine the gross rent multiplier for you to maximize its uses.
Benefits of Gross Rent Multiplier
- Facilities to compare similar houses on the same market are easy to use.
- A quick formula that can be employed to appraise rental property by starting rental investors.
- GRM is a great screening tool to determine the most promising possibilities for real estate investing.
- GRM focuses instead of real estate price, price per square ft, or price per unit, on the generated rental revenue.
- Both sellers and purchasers may use the gross rental multiplier for the rental property. For instance, a seller with a fully upgraded home for large renters can have a higher price and a lower GRM. Buyers who are seeking a good bargain look for a lower GRM property because the cost may be lower than the market or because the gross rent is higher.
Limitations of a Gross Rent Multiplier
Even though GRM is simple in calculation and provides a rough estimate of what purchasing the property can mean to a buyer, it’s hardly a practical valuation method. There are genuine limitations that go along with this calculation method, such as:
- The inability to factor in interest rates, which affect property rates and influence trends in the real estate market;
- GRM makes no distinction between different property types, nor does it factor in the property’s condition or age;
- GRM values the property on gross income while properties are purchased on net income; and
- GRM ignores other important factors such as insurance, property tax, and vacancy rates in the calculation.
Conclusion:
In calculating the gross rent multiplier, it is essential to factor in operating costs before deciding whether or not to invest in the property. Operational costs can derail the investment if they cost more over time than what you paid for the property. Complete understanding of Gross rent multiplier calculation is an advantage specifically for investors.
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