The gross rent multiplier (GRM) is a vital tool to calculate the potential profits of investment rental properties. The GRM helps real estate investors compare properties based on their value and projected gross annual income. The result represents the number of years it takes for the investment to pay for itself. A lower number represents a better investment.
When it comes to comparing several real estate investment opportunities, the GRM has many advantages. For example, you can quickly and easily determine a property’s potential based on a few figures. But, the simplicity of the GRM also means that it has limited use in what it can tell real estate investors.
This beginner’s guide to the gross rent multiplier looks at its uses and limitations. You will also learn how to use the GRM to find the best potential real estate investments in your desired area.
What is GRM in Real Estate?
Gross rent multiplier uses the property’s valuation and the projected total yearly income to vet, value, and compare investment properties. The ratio of the gross income to value gives a handy, uncomplicated metric. Most real estate investors use GRM as a starting point when screening potential investment opportunities.
GRM divides the current property value by the projected gross income. Some investors may include anticipated expenses along with the cost of buying the property. But, most investors use only gross income in the formula without accounting for general running costs. In the end, you need to know how quickly you will see a return on your investment (ROI).
Use the GRM Formula to Discover Real Estate Investments
Also called the gross income multiplier, the GRM multiplier formula is this: divide the property’s asking price by gross annual rent.
Let's use an example of how the GRM is useful for evaluating the potential of a real estate investment rental property.
A rental property is selling for $500,000, and you calculate that it will generate a monthly income of $5,500. To calculate GRM, multiply the monthly income by 12. This gives us a gross annual rent of $66,000. Now we’ve got our two metrics for the GRM formula.
Gross rent multiplier = $500,000 ÷ $66,000 = 7.58.
The gross rent multiplier for the property is 7.58. What does that tell you? This metric is the number of years it takes for the investment to pay for itself. But on its own, the figure doesn’t tell you very much. However, when you use GRM to calculate the investment value of several properties, its usefulness becomes evident.
Of course, there is much that the gross rate multiplier can’t tell you. The GRM doesn’t take into account loan payments, higher maintenance expenses, repairs, or similar costs. But as a benchmark for comparing one property with another one, GRM is an excellent tool.
What is a Good Gross Rent Multiplier?
A good GRM depends on various factors in the real estate investment market. In all cases, lower GRMs represent better investments. And, most investors prefer GRMs in single digits. But the health of the market, property prices, property type, and neighborhood all affect the gross rent multiplier.
As a general rule, the lower the GRM, the more reward you can expect from the investment. Lower GRMs mean that you get more rent in relation to the cost of the property. For example, a property with a GRM of 4 means you will start making a profit faster than one with a rating of 7.
The gross rent multiplier also helps identify a property that may seem expensive, but in reality, it could be a better investment than a cheaper one. For example, an exclusive apartment building in a sought-after neighborhood could seem like a substantial investment. But comparing it with cheaper properties could reveal that the exclusive apartment building pays for itself faster. Now, it looks like a no-brainer to invest in the more expensive property.
Here are three crucial things to remember when coming up with a good GRM:
- Use gross income multiplier to compare similar property types in similar real estate markets. For example, don't use to compare industrial buildings with multifamily buildings.
- Only use GRM as a screening method. You need to analyze all operating costs and liabilities before committing to a deal.
- There is no magical number when it comes to GRM. The metrics are relative to real estate market conditions.
Although there is no ideal figure for the gross rent multiplier, many investors aim for the 1% rule. This rule is that the annual gross rental income should be 1 percent of the property's value.
Pros of the Gross Rate Multiplier
GRM is an invaluable tool for property investors. Compared to other methods of analyzing investment opportunities, using the gross rate multiplier has several advantages. Let’s look at GRM’s many benefits:
- Ideal for rental properties: Using the GRM tool is perfect for evaluating rental property investment potential. It is easy to find the ratio of gross income to property value. By placing the GRM of several rental properties side-by-side, you can quickly identify the best investment possibilities.
- Fast and easy: There are no complicated calculations with the gross rental multiplier. You only need to compare similar types of properties.
- Screen several properties at once: As a powerful tool, GRM allows you to set a benchmark for comparing many properties. You can compare and contrast real estate in different neighborhoods, cities, and even various parts of the country.
- Reliable: Gross rent multiplier is a tool that provides consistent results. Rental income is market-driven, and using this is a reliable way to compare hundreds of properties at once.
Cons of the Gross Rate Multiplier
Although GRM is extremely useful, it has its limitations. After all, it is a starting point when identifying profitable real estate ventures. What are the disadvantages of gross rent multiplier method? Here are a few:
- It does not consider all costs: GRM only takes into account two figures, the property’s price and gross rental income. But, managing a rental involves more than only collecting rent. Operating costs that GRM doesn’t include are vacancy rates, insurance, maintenance, and other expenses.
- It’s not always accurate: Using gross income multiplier can’t always calculate a proper return on investment. For example, repair costs, loan repayments, or other operating expenses can impact your investment performance and net income. It's still crucial to thoroughly analyze all running costs after narrowing your search using GRM.
- You may miss an excellent property: After crunching the numbers to narrow down your properties, it could be easy to miss a potential goldmine. The GRMs are excellent for quickly screening hundreds of properties, but there's always a chance the one slips through the net.
How to Use the Gross Income Multiplier
There are many ways to use GRM in real estate, especially if you plan on buying rental properties.
Use GRM to narrow down your search
The most common reason for using the gross rent multiplier method is to quickly screen potential investment opportunities. It is easy to find a property’s price-to-rent ratio and compare it with similar-type buildings. If you find one or two similar properties with a much lower GRM, then it’s worth more investigation.
You can also use GRM to expand your search to other cities. For example, you may find that the average GRM in smaller cities is significantly lower. Armed with this knowledge, you could start looking for rentals in those areas that offer a better and faster ROI.
Gross rent multiplier for buying profitable real estate
Getting started in the rental real estate business can be daunting. There is a diverse range of commercial real estate investments in multifamily complexes, industrial, retail, or single-family units. Using GRM is an easy way to narrow down your options.
Here is an example of how GRM in real estate can help identify the best rental investments.
An investor has identified three multifamily buildings, all located within the same city and same neighborhood. Each property has between 25 and 30 individual units. The three properties are all Class A. Here is how GRM helps the investors decide on which property to investigate:
- Property #1—Selling for $950,000, and gross annual rental income is $85,000. GRM is 11.2.
- Property #2—Selling for $2.2 million, and gross annual rental income is $205,000. GRM is 10.7.
- Property #3—Selling for 3.25 million, and gross annual income is $375,000. GRM is 8.8.
After considering all three options, it’s clear to our investor that property #3 look like a good deal and is worth carrying out due diligence.
Use GRM to track property values
The gross rent multiplier is also useful in real estate to estimate a rental property's current market value. For example, if you decide to sell your property and want to know the asking price. All you need to do is flip the GRM formula around to work out its approximate value in the current market.
Here is the GRM formula to work out property values:
Property value = Gross annual income x GRM.
If your property has a GRM of 7.6, and your gross annual rental income is $310,000, your starting price when selling the property should be $2,356,000.
This calculation can also help you determine if you’re currently charging enough in rent. If you find that the property value based on GRM is lower than similar properties, you could consider increasing rent.
Gross Rent Multiplier: A Takeaway
Using the gross income multiplier is one of the quickest ways to compare and contrast potential investment properties. The GRM for real estate allows investors to establish a benchmark when valuing properties. After that, due diligence will determine if the rental property is worth buying as a solid investment.