The gross rent multiplier can be a valuable metric for quickly estimating a rental property’s earning potential and comparing it to other similar houses in the area. Or, if you know the GRM but don’t know either the market value or a property’s annual income, it can be helpful in doing a reverse calculation. Here’s a closer look at how to calculate GRM and use it in practice.
How to Calculate GRM
To calculate the gross rent multiplier, you divide the fair market value by the gross rental income. That means the GRM formula is as follows:
GRM = Fair Market Value / Gross Rental Income
Here’s an example of how to calculate the gross rent multiplier. Say you have one property worth $250,000 that would yield about $2,500 per month in rental income. Your GRM calculation would look like this:
GRM = $250,000 / ($2,500 x 12) = 8.33
Now say there’s another property in the neighborhood worth $400,000 and yields $5,000 per month in rent. The GRM calculation for that property would look like this:
GRM = $400,000 / ($5,000 x 12) = 6.66
You could continue to do this calculation for every property you’re considering and note the GRM for each.
Or say you know the market value of a property is $300,000 and the average GRM in the neighborhood is 6. You could reverse the calculation to determine the annual rent.
Gross Rental Income = Market Value / GRM = $300,000 / 6 = $50,000
While it may not be entirely accurate since you’re using a general average, it can help you get a rough estimate.
What is a Good Gross Rent Multiplier?
A good GRM is between 4 and 7, according to most investors. However, it all depends on the area and your investing goals. As a general rule, the lower the gross rent multiplier, the better. Some areas naturally have higher GRMs but still present good opportunities. But, typically, the lower the GRM, the sooner you’ll be able to pay off the loan or recoup your investment.
However, just because the GRM is low doesn’t guarantee the property is a good investment. GRM doesn’t account for the expenses you need to put into a home to bring it to market value. So, a property could have a very low GRM but requires a complete gut renovation. That would mean it would take more time to be profitable than a similar property with a slightly higher GRM that requires less work. So GRM is just one metric you should use to analyze an investment.
Gross Rent Multiplier vs. Cap Rate
It’s important to note that GRM is not the same as the cap rate, another tool used to determine the potential value of an investment. Cap rate is a metric used to estimate the profitability of a commercial real estate investment by dividing the net operating income by the value of the asset. Net operating income is calculated by subtracting the expenses related to running the property from the gross cash flow.
So, while GRM and cap rate are similar calculations, there are vital distinctions. Cap rate is expressed as a parentage, whereas GRM is expressed as a ratio. To calculate the cap rate, you must determine the net operating expenses of the property. So, it’s better for analyzing a property’s current or expected value, whereas GRM is better for quickly evaluating the future potential of an investment.
Gross Rent Multiplier Bottom Line
Gross rent multiplier is a valuable tool for comparing rental property investment opportunities. When you’re analyzing a particular market and looking at many different properties, it can be challenging to identify the best deals because so many factors may impact your profits.
So, GRM makes it easy to break down the potential of an investment into a simple metric that can be used to compare properties quickly. But it does have its limitations and doesn’t necessarily give you the complete picture. So, while it may be helpful for quickly comparing similar properties, you can’t use GRM alone to predict the viability of an investment.