If you are looking to invest in real estate, you may want to use the gross rent multiplier to determine whether or not a property is worth purchasing. Many investors are surprised to find that the GRM is relatively straightforward and doesn’t need any advanced math knowledge to use it.
In this article, we’ll break down how to calculate it, along with some clear examples of how to use GRM.
What is a gross rent multiplier?
The gross rent multiplier (GRM) consists of a metric that will provide you with the information you need to figure out whether the rental property will give you a good return on your real estate investment property. It is also referred to as the gross income multiplier (GIM).
Why is the Gross Rent Multiplier Important?
Real estate investors use the GRM to help determine whether or not they should purchase a property quickly. It’s not uncommon for hundreds of different homes for sale in specific markets, with many of them selling within a matter of hours.
Analyzing potential investment properties can be overwhelming for many buyers. This feeling is especially true in a hot real estate market, where inventory is limited and not a lot of time to make a well-informed decision. In addition, if they have a limited amount of funds, they may only be able to afford to purchase one property at a time.
Therefore, investors need to make sure that they invest in a property that will allow them to make the most money. The GRM will take some of the stress out of figuring out which property to invest in.
How to Calculate GRM
To calculate a gross rent multiplier on a specific property, you will need to divide the selling price of the property by the gross received rent.
Gross Rent Multiplier Formula = property price / gross annual income
Usually, it’s best to choose the property with the lower GRM. In the GRM formula, you can calculate the GRM using either the gross annual rental income or the gross monthly rental income. Additionally, many investors use the annual rent rather than the amount they expect to receive in rent monthly.
Gross Rent Multiplier example
Consider this example below to help figure out precisely what the GRM looks like:
Property A: This property consists of three units in a multi-family triplex that an owner lists with a sales price of $300,000. The monthly rent for each unit is $1,000 and receives $36,000 in annual gross rent. The GRM for this property is 8.33 ($300,000 / $36,000).
Property B: This property is a single-family home that an owner lists for a purchase price of $100,000. Although it’s a small home, the owner can rent it for $1,200 a month because there aren’t a lot of other homes for rent in the area. Thus, the annual rental income is $14,400. The GRM for this property is 6.94 ($100,00 / $1,200).
Property C: This property consists of two units in a duplex with a list price of $200,000. The homeowner rents each unit for $900 a month, and they receive $21,600 in rent annually. The GRM for this property is 9.26 ($200,000 / $21,600).
Striving to choose the property with the lowest GRM, we can see that Property B may be the best property to purchase according to the GRM calculation.
However, it is essential to note that investors need to consider other variables.
For example, if investors need to repair the property, these expenses reduce the potential profit. Thus, the GRM is only one of many calculations investors need to do when analyzing a property.
What is a Reasonable Gross Rent Multiplier?
Investors often use the annual rent of a property to help them determine whether or not the GRM is reasonable. Traditionally, many real estate investors aim to purchase properties with an average GRM of 7 or less. However, if the number is above this, they may have difficulty paying the property off and keeping up with maintenance, as the rent may not be sufficient to cover all of this.
However, the answer to “What is a good gross rent multiplier” depends on other factors. They include the location of the property and the amount of other rental properties in the area. In addition, the fair market value of rent can also change quite a bit from year-to-year.
Because of this, some investors will choose a property with a higher GRM because they feel that they will be able to raise the rent on the property in the upcoming years, which is typical for areas that are seeing a lot of development and rise in property value.
Pros and Cons
Even though the GRM is a valuable tool, investors will find some pros and cons of using it.
One of the most significant advantages of using it is that the real estate investor doesn’t have to use any particular program to figure out the GRM. They can calculate this number reasonably quickly, and this may allow them to put a bid in on a property that they are interested in before other investors have the chance to even look at it.
This calculation is crucial for sellers selling properties for a lot less than what they are worth because they are in foreclosure or selling as a short sale. Using the GRM, you won’t have to waste time figuring out whether a property is worth the investment.
While there are a lot of benefits to using the GRM, there are some cons to using it as well. Just because a property comes back with a low GRM doesn’t necessarily mean it will be worth investing in. Some properties will need a lot of updating, and this will cause the investor to have to spend a lot of money that they didn’t intend to.
If a property is located in a less-than-ideal area, they may find that there are times where they are losing money because the property sits vacant for several months in between renters. Because of all of this, you need to remember that the GRM is only one factor you should consider when looking at investment properties.
It would help if you looked at the whole picture before you decide to make a purchase.
Gross Rent Multiplier vs. Cap Rate
Some investors find that a property’s cap rate is a more useful tool than the GRM as it gives them a better understanding of how much they may be able to make off of a property. This reason is that the cap rate considers the property’s net income after the investor has paid for things like taxes, insurance, and repairs.
The capitalization rate is typical in commercial real estate, such as an apartment building, but it is also helpful in residential transactions. Many investors use the GRM rather than the cap rate because they may have difficulty determining how much they will need to pay for things like repairs or insurance each month.
To learn more about the cap rate calculation, check out the article: How to Calculate Cap Rate Easy + Free Cap Rate Calculator.
GRM vs. Cash-on-cash
Investors interested in properties that require repairs before renting them out may use the cash-on-cash return method rather than the GRM. They will have to add up the down payment and rehab costs before renting out the property.
After they add all of this up, they will have their out-of-pocket acquisition.
Next, the investors will calculate the net operating income (NOI) by subtracting annual expenses from the gross annual rent.
Net Operating Income Formula = Annual gross rent minus annual expenses
Examples of operating expenses are mortgage payment, utilities, property management fees, vacancy rates, property taxes, insurance, etc.
The investors would then use their expected annual cash flow and divide it by their total acquisition cost.
For example, if they had an acquisition cost of $25,000 with an annual cash flow of 2,000, their cash-on-cash return yields 8% ($2,000 / $25,000).
To learn more about calculating the cash-on-cash return, check out the article: SUPER EASY WAY To Calculate Cash on Cash Return
If you’re interested in buying an investment property to make money, it’s essential to do your due diligence by researching comparable properties.
The GRM is excellent when trying to compare similar properties when the depreciation effects, periodic costs, and other expenses are equal. However, the gross rent multiplier is just one analysis tool of many valuation methods for analyzing investment properties.
When it comes to selecting investment properties, it all comes down to how an investor values a property.
Although calculations are great at filtering bad deals, when it comes to real estate investing, it’s important not to get caught in analysis paralysis for the sake of finding the perfect deal. Thus, it’s essential to set aside a portion of the gross rental income towards unexpected expenses.