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Choosing a rental property to purchase can be complicated — even for experienced real estate investors. That’s why it’s important to have a reliable set of analytical tools that take the guesswork out of real estate investing.
One of those tools is the gross rent multiplier formula (GRM).
The gross rent multiplier can give real estate investors a good idea of a rental property’s prospects for lucrative returns — and how long it may take to realize profits.
What is the Gross Rent Multiplier (GRM)?
The gross rent multiplier is a formula for estimating a rental property's worth based on its income.
It's one of several methods employed by investors to find, evaluate, and differentiate properties.
What makes the gross rent multiplier formula different from others is that it only considers gross income.
Gross rent multiplier can help real estate investors learn two important items about a property:
- It helps to determine the fair market value for a property
- It calculates the gross rent for a property
Next, we’ll take a closer look at each one.
Determine the Fair Market for A Property with GRM
The gross rent multiplier formula is a measurement used by investors to determine whether the asking price for a rental property is fair and whether or not they're getting a good value.
It can give a clue about a building’s true value when the resulting ratio is compared with other buildings in the surrounding area.
If you can find the average gross rent multiplier of rental properties in the area (a local real estate agent or appraiser can help), real estate investors can use GRM to calculate a better estimate of a property’s real worth.
Calculate Gross Rent
Evaluating income-producing properties isn’t just assessed for its condition, improvements, and size; it’s also judged on how well it can generate revenue.
Using gross rent multiplier, real estate investors can calculate what the gross rent should be to make a profit and to offer fair rent prices.
Gross Rent Multiplier Formula
For such important measures, gross rent multiplier an amazingly simple calculation.
The formula is as follows:
Gross Rent Multiplier = Property Price / Gross Annual Rental Income
The resulting number is the GRM.
Pros of Gross Rent Multiplier
Some of the advantages of using the gross rent multiplier formula include:
You can’t get much simpler than a one-step math calculation, especially when it comes to real estate calculations.
Easily Obtained Information
You only need two numbers to calculate the gross rent multiplier, both of which are easily obtained.
One is the asking price of the property, which should already be common knowledge.
The other is the annual rental income, which should be part of the owner’s “selling points.”
Helpful Screening Tool
When an investor is looking at dozens of rental properties to find the best investment candidates, the gross rent multiplier can help to filter or compare certain opportunities.
Cons of Gross Rent Multiplier
A few drawbacks to using the gross rent multiplier formula by itself include:
Doesn’t Account for Future Value Changes
The GRM doesn’t factor in long-term appreciation or depreciation in the rental property value.
These are important considerations when you’re buying a rental property.
Exclusion of Other Expenses
The gross rent multiplier ignores some of the costs and losses associated with rental properties, including vacancy, taxes, and operating expenses.
Only Uses Gross Income
Net operating income may be a more precise indicator of a rental property’s overall value, though gross rent multiplier only uses gross income.
What is a Good Gross Rent Multiplier (GRM)?
Whether a gross rent multiplier is favorable or not depends on overall market conditions.
After a recession, for example, the average GRM may be lower with real estate trends slowly getting back to normal.
As the real estate market improves and cash flow increases at a higher amount than rent prices, the GRM may go up into the double-digit range.
It can also be different state to state and city to city. It is worthwhile to create a gross rent multiplier scale for the area you’re interested in investing in.
A simple rule is that a rental property with a lower gross rent multiplier may represent a more promising investment opportunity, because the lower your gross rent multiplier is, the less time it will take your rental property to pay off the price you purchased it for.
Many investors like to see a GRM between 4 and 7, since that implies it won't take too long to recoup the price of purchase.
Gross Rent Multiplier Example
Let’s look at a gross rent multiplier example.
Say that you’re looking at an apartment building that’s priced at $3,250,000.
Annual rental income on this property totals $500,000.
The gross rent multiplier calculation would be:
3,250,000 / 500,000 = 6.50
Thus, the GRM on this property is 6.50.
Now, imagine that the average gross rent multiplier in the neighborhood is 6.1.
You would then multiply that number by the building's annual income revenue of $500,000.
$500.000 x 6.1 = $3,050,000
The building may be overpriced by $200,000.
However, that’s not a one size fits all rule. Other factors must be taken into consideration, such as:
- the surrounding buildings are overpriced
- economic factors
- The city and community the property is located in
The Bottom Line: GRM
Thanks to its simplicity and reliability as a benchmark, the gross rent multiplier is one of the most commonly used indicators of a rental property’s true value.
It can point an investor toward opportunities that will pay off in the future, while steering them away from those that won’t.
But the gross rent multiplier formula should only be one component of your evaluation strategy.
Other formulas to factor in include:
- cash on cash return
- after repair value (ARV)
The best way to ensure your next deal is profitable is to increase your real estate education with additional educational resources.