Trying to figure out which rental property is the better investment can be pretty tricky, especially if you are new to real estate. Fortunately, you may use a few crucial financial measures to determine which income-producing property is superior to the others. This article will dive into the gross rent multiplier and how you can use it to better your success in real estate as an agent or an investor and help you be ready for any questions when it comes time for the exam.
What is the Gross Rent Multiplier?
The gross rent multiplier is a calculation used by real estate professionals to determine how quickly an investment property can be paid off.
Real estate investors utilize the gross rent multiplier, or GRM, to analyze potential investment properties. It’s used to evaluate and rate the potential properties based on their rental revenue and market worth. Investors may quickly determine which properties are worth their time and money by looking at the property price and gross rental income.
What is the Gross Rent Multiplier Formula?
To calculate the gross rent multiplier, you simply need two things: the property price or purchase price, along with the gross rental income.
Gross Rent Multiplier (GRM) = Price (Property/Purchase Price) ÷ Gross Annual Rental Income
Generally speaking, a lower GRM means it’s a good investment opportunity. If you’re deciding between two nearly identical rental properties, the one with a gross rent multiplier of 95 may be a better investment than one with a GRM of 100.
It’s worth mentioning when it comes to the GRM; many real estate investors have their own rules. Some investors, for example, will not even consider a property unless it has a gross rent multiplier of 100 or less based on the estimated monthly rent.
Gross Rent Multiplier Example
We’ll use a tiny four-unit multifamily property as an example to demonstrate how to compute the gross rent multiplier ratio. The GRM would be 7.90 if the property generates a gross annual rent of $50,600 and the asking price is $400,000 for the property.
400,000 / 50,600 = 7.90
A GRM of 7.90 is neither good nor bad on its own because there is nothing to compare it to. However, many investors utilize the rule of thumb that the lower the gross rent multiplier is relative to other similar properties in the same market, the more attractive the investment is. This is because the property generates a higher gross rental income than the alternative properties, allowing it to pay for itself more quickly.
When the value of an income-producing property is unknown, a gross rent multiplier might be used to estimate its worth. For example, suppose a rental property generates $100,000 in annual revenue, and the average GRM of similar properties in the area is roughly 8. In that case, we can multiply the two ($100,000 * 8) to get a property estimate of $800,000. While this isn’t a perfect calculation, it might provide a valuable assessment for a property investor when comparing different homes.
What is a Good Gross Rent Multiplier?
Generally speaking, the lower the gross rent multiplier, the better. Remember, the lower the GRM, the quicker the property owner can return their initial investment.
The GRM in the example mentioned earlier was 7.90. This indicated that the four-unit multifamily rental property would take roughly 8 years to pay off. As we mentioned before, the lower the gross rent multiplier rates, the better. Say you compare another property that has a GRM of 12.6. It would take you roughly 13 years to reach the payoff period and be making a profit. So the better choice would be the four-unit multifamily rental property in the example showing it would only take about 8 years to reach that point.
Using the gross rent multiplier does have some limits not taken into account in the calculation. The GRM method does not account for the expenses and operating expenses associated with the purchase of a real estate property because the annual gross rent is employed in the equation. These additional costs are made up of annual operation expenses, maintenance fees, and property taxes. Because of the variation, a good GRM could be different in area but not in another. For example, larger cities with higher living standards have a higher GRM due to the high cost of rent and investment property in the neighborhood.
With all that being said, no matter where you live, in almost all circumstances, the lower the gross rent multiplier, the better. Typically, investors and real estate experts consider a GRM of 4 to 7 to be “good.”
Advantages and Disadvantages
As with everything in life, there are advantages and disadvantages. The gross rent multiplier has both advantages and downsides as a property appraisal tool. Knowing this can assist you in determining where the GRM is most beneficial when to apply it and what the calculation entails.
The gross rent multiplier has the advantage of being simple to use. To calculate it, simply divide the property’s price by the projected monthly rent. It’s that simple. The gross rent multiplier can help you narrow down hundreds or even thousands of real estate listings into a manageable number of options.
Here are a few advantages and reasons why you should use a gross rent multiplier:
- It’s a simple, no-brainer formula. A properties GRM can be computed in as little as five minutes.
- You can easily compare other properties with GRM’s. Instead of guessing what property may be a better investment, with GRM’s you can easily compare and narrow down your options.
- It is versatile. GRM is useful whether you are a buyer or a seller. A seller who wants to rent out his house may use the equation to price it, while a thrifty buyer could look for GRMs that are lower on the market to save money.
But, like with everything, there are some disadvantages. Here are a few disadvantages of using a gross rent multiplier:
- And as we mentioned before, costs are not taken into account. The GRM formula is a property value method based on income and income only. Operating expenses, repair, higher maintenance costs, and property taxes reduce the profit.
- It is not precise. Because insurance costs, vacancy rates, and other supplementary fees are not factored into the gross rent multiplier, it does not fully capture the property’s potential. This is why GRMs are frequently utilized solely for preliminary screening. A more in-depth analysis of a real estate property is the finest compliment to the calculation.
Gross Rent Multiplier vs. Capitalization Rate
A cap rate, or capitalization rate, is the rate of return on a real estate investment property based on the net income that the property is expected to generate. Capitalization rates are more beneficial when determining the profitability of an investment property since it analyzes the property’s net revenue after expenses such as property taxes, insurance, and other costs, rather than just its gross income.
To determine the cap rate, divide the property’s annual net operating income (NOI) by its cost and multiply by 100 to convert it to a percentage.
The difference between a cap rate and GRM is that the cap rate looks at net income, while the GRM looks at gross income.
While cap rates are more accurate, most investors prefer the GRM over the cap rate since calculating and locating a property’s running expenses is complicated and time-consuming. Investors use the GRM since it is the quickest and most convenient method.
What to Know as a Real Estate Investor
As a real estate investor, you want to make the most money possible and maximize your investment in a rental property. That is where these helpful tools come into play to ensure that you do.
When utilizing this, remember that the GRM is one of the most efficient ways to evaluate its profitability to other properties in the same real estate market. The gross income multiplier (GIM) is a version of GRM used when calculating non-rental sources of income such as vending machines or coin-laundry machines.
You can also utilize the capitalization rate to determine additional costs not covered in the GRM formula, although most investors prefer to use the GRM method first. When using it for potential investment properties, you want your GRM number to be as low as possible, but be careful it is not a property that may cost too much in repairs and regular maintenance.
It is essential to remember that these tools have advantages and disadvantages, just like anything.
What to Know for the Real Estate Exam
GRM is another real estate math related topic, that you need to know come exam day. Remember, the gross rent multiplier is a calculation used by real estate professionals to determine how quickly an investment property can be paid off. It can be calculated by taking the purchase price or property value and dividing it by the gross rental income. Remember, the lower the number, the better! But, don’t forget that this method does not consider certain normal operating expenses. With this knowledge in mind, you will be sure to ace your exam!
Still stuck? Check out one of our real estate math videos down below on how to calculate the gross rent multiplier: