Calculate Gross Rent Multiplier and How It Is Used by Investors

Calculating and using the Gross Rent Multiplier

What is the Gross Rent Multiplier (GRM)?

The Gross Rent Multiplier (GRM) is a quick calculation used by real estate analysts and investors to assess the value of a rental property. It represents the ratio of the property’s price (or value) to its annual gross rental income.

The GRM is useful because it provides a quick assessment of the potential returns on investment and is useful as a way to screen for potential investments. However, the Gross Rent Multiplier should not be used in isolation and more detailed analysis should be performed before deciding on investing in a property.

Definition and Significance

The Gross Rent Multiplier is used in commercial real estate as a “back-of-the-envelope” screening tool and for assessing comparable properties similar to the price per square foot metric. However, the GRM is not usually applied to residential real estate with the exception of large apartment complexes (typically five or more units).

Like with many valuation multiples, the Gross Rent Multiplier may be seen as a rough estimate for the payback period of a property. For example, if the GRM yields a value of 8x, it can take approximately eight years for the investment to be paid back. However, there is further nuance around this interpretation discussed later in this article.

Use Cases in Real Estate

Calculating the GRM enables potential investors and analysts to quickly assess the value and feasibility of a potential property. This simple calculation allows investors and analysts to quickly screen properties to determine which ones might be good investment opportunities and which ones might be poor.

What is the Formula for Calculating the Gross Rent Multiplier?

The Gross Rent Multiplier calculation is relatively straightforward: it’s the property value divided by gross rental income. More formally:

Gross Rent Multiplier = Property Price ÷ Annual Gross Rental Income

Let’s further discuss the two metrics used in this calculation.

Property Price

There is no readily available quoted price for properties since real estate is an illiquid investment. Therefore, real estate professionals will typically use the sales price or asking price in the numerator.

Alternatively, if the property has recently been appraised at fair market value, then this number can be used. In some instances, the replacement cost or cost-to-build may be used instead. Regardless, the property price used in the GRM calculation assumes this value reflects the current market value.

Annual Gross Rental Income

Annual gross rental income is the amount of rental income the property is expected to produce. Depending on the property and the terms, rent or lease payments may be made monthly. If this is the case, then the monthly rent amounts can be converted to annual amounts by multiplying by 12.

One key point for analysts and real estate investors to be aware of is calculating the annual gross rental income. By definition, gross amounts are before expenses or other deductions and may not represent the actual income that a real estate investor may collect.

For example, gross rental income does not generally consider potential uncollectible amounts from tenants who become unable to pay. Additionally, there may be various incentives offered to tenants in order to get them to lease the property. These incentives effectively reduce the rent a tenant pays.

Gross rental income may include other sources of income if applicable. For example, a landlord may separately charge for parking on the property. These additional income streams may be considered when evaluating the GRM but not all practitioners include these other revenue sources in the GRM calculation.

Bottom line: the GRM is roughly similar to the Enterprise Value-to-Sales multiple (EV/Sales). However, neither the Gross Rent Multiplier nor the EV/Sales multiple take into account expenses or costs related to the property or the company (in the EV/Sales’ use case).

Gross Rent Multiplier Examples

To calculate the Gross Rent Multiplier, consider a property listed for $1,500,000 that generates $21,000 per month in rent. We first annualize the monthly rent by multiplying it by 12, which returns an annual rent of $252,000 ($21,000 * 12).

The GRM of 6.0x is calculated by taking the property price and dividing it by the annual rent ($1,500,000 ÷ $252,000). The 6.0x multiple could then be compared to other, similar properties under consideration.

Interpretation of the GRM

Similar to valuation multiples like EV/Sales or P/E, a high GRM might imply the property is overvalued. Likewise, a low GRM might indicate a good investment opportunity.

As with many metrics, GRM should not be used in isolation. More detailed due diligence should be performed when deciding on investing in a property. For example, further analysis on maintenance costs and vacancy rates should be performed as these are not specifically included in the GRM calculation.

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Why is the Gross Rent Multiplier Important for Real Estate Investors?

The GRM is best used as a quick screen to decide whether to allocate resources to further evaluate a property or properties. It allows real estate investors to compare property values to the rental income, allowing for better comparability between different properties.

Alternatives to the Gross Rent Multiplier

Gross Income Multiplier

Some real estate investors prefer to use the Gross Income Multiplier (GIM). This calculation is very similar to GRM: the Property Value divided by the Effective Gross Income (instead of the Gross Rental Income).

The main difference between the Effective Gross Income and the Gross Rental Income is that the effective income measures the rent after deducting expected credit or collection losses. Additionally, the income used in the GRM may sometimes exclude additional fees like parking fees, while the Effective Gross Income includes all sources of potential revenue.

Cap Rate

The capitalization rate (or cap rate) is calculated by dividing the net operating income (NOI) by the property value (sales price or market value). This metric is widely used by real estate investors looking to understand the potential return on investment of a property. A higher cap rate typically indicates a higher return but may also reflect higher risk or an undervalued property.

The main differences between the cap rate and the GRM are:

1) The cap rate is expressed as a percentage, while the GRM is a multiple. Therefore, a higher cap rate is usually considered better (ignoring other factors), while a higher GRM is usually indicative of an overvalued property (again ignoring other factors).

2) The cap rate uses net operating income instead of gross rental income. Net operating income subtracts all operating costs from the total revenue generated by the property, while gross income doesn’t deduct any costs. Because of this, NOI provides better insight into the potential profitability of a property. The difference in metrics is roughly similar to the difference between traditional financial metrics like EBITDA versus Sales. Since NOI factors in property expenses, it’s more appropriate to use NOI when determining the payback period.

Advantages and Limitations of the Gross Rent Multiplier

Calculating and analyzing the Gross Rent Multiplier is crucial for anyone involved in commercial real estate. Proper interpretation of this metric helps make well-informed decisions and evaluate investment potential.

Like any valuation metric, it’s important to be aware of the advantages and disadvantage of the Gross Rent Multiplier.

Advantages

• Simplicity: Calculating the GRM is relatively simple and provides an intuitive metric that can be easily communicated and interpreted.
• Comparability: Since the GRM is a ratio, it scales the property value by its expected income, allowing users to compare different properties. By comparing the GRMs of various properties, investors can identify which properties might offer better value for money.

Limitations

• Excludes Operating Expenses: A major limitation of the GRM is that it does not take into account the operating expenses of a property. Maintenance costs, insurance, and taxes can greatly impact the actual profitability of a property.
• Does Not Consider Vacancies: Another limitation is that GRM does not consider vacancy rates. A property might show a favorable GRM, but changes in vacancy rates can drastically reduce the actual income from tenants.

Conclusion

The Gross Rent Multiplier is a valuable tool for any real estate investor. It’s useful for quick comparisons and initial evaluations of potential real estate investments. While it should not be used in isolation, when combined with more in-depth analysis, the GRM can significantly enhance decision-making and resource allocation in real estate investing.

Additional Resources

Thank you for reading CFI’s guide on the Gross Rent Multiplier. To keep advancing your career and skills, the following CFI resources will be useful:

• Real Estate Appraiser
• Fair Market Value
• Foundations of Real Estate Financial Modeling
• Best Commercial Real Estate Certifications and Designations
• See all Commercial Real Estate resources