The Gross Rent Multiplier (GRM) is a key tool that investors use to figure out the relationship between a property's price and its rental income. But like any tool in real estate, its effectiveness is tied to your understanding of how it is used.
So, what exactly is a 'good' GRM for rental properties, and how can you interpret its results effectively? Read this comprehensive guide about GRM and join us as we review its pros and cons, how to use it for your rental property investments, and more!
The Gross Rent Multiplier (GRM) is a core real estate measuring tool used by investors to assess the value and profitability of rental properties. Essentially, GRM is a ratio that measures the relationship between the price of a property and its potential rental income.
It is calculated by taking the purchase price or market value of the property and dividing it by the gross annual rental income. This provides a quick overview of how many years it would take for the property to pay for itself through its rental income, assuming no change in income and excluding operating expenses.
A lower GRM may indicate a potentially more profitable property, while a higher GRM could suggest the property is overpriced in relation to its rental potential.
However, it's essential to understand that the GRM offers a very high-level overview. It doesn't account for the property's operating expenses, financing costs, or other aspects of the real estate market.
While the GRM is a valuable initial tool for gauging the attractiveness of a rental property, it should be used with other tools to make informed real estate investment decisions. When utilized correctly, the GRM can help real estate investors identify potentially undervalued investment properties or markets that they can invest in.
As mentioned, calculating the Gross Rent Multiplier (GRM) is a straightforward process that allows investors to quickly assess the potential value and profitability of a rental property.
As a good rule of thumb, you'll be using two primary pieces of data: the purchase price or market value of the property and the property's gross annual rental income.
First, you should determine the property's gross annual rental income. If you're looking at a property that's already being rented out, you can take the current monthly rent and multiply it by 12 to get this figure.
For residential or commercial properties that are not currently rented or if you anticipate a change in the rent, you'd use the projected annual rent.
Once you have the gross annual rental income, you then divide the property's purchase price or its current market value by this annual rental figure. The resulting number is the Gross Rent Multiplier. In mathematical terms, the gross rent multiplier formula is:
GRM = Property Price or Market Value/Gross Annual Rental Income
It's important to remember that the GRM is a ratio, not a percentage used by real estate investors. So, if the property has a GRM of 7 or 8 after you use the gross rental multiplier, for instance, this indicates that it would take approximately 7 or 8 years of gross rental income (without considering expenses) to equal the property's current value or price.
Determining what constitutes a "good" Gross Rent Multiplier (GRM) is subjective and largely depends on local market conditions, the investor's goals, and other underlying variables aside from the annual gross rental income.
However, while there's no universal suggestion on which GRM is best, investors should aim for lower GRMs like a GRM between 4 and 7 or a GRM of 7.5. The lower the GRM (for example, a GRM of 4), the fewer years required for the rental income to equate to the property's price. On the other hand, a higher GRM might signal that a property is overpriced in relation to its rental potential.
It's vital, however, to keep in mind that in areas with higher demand, like bustling city centers or established neighborhoods with amenities and strong school districts, properties might naturally have higher GRMs. This is because the perceived value and potential for appreciation in such areas can justify the higher initial investment.
On the other hand, properties in emerging or less developed areas might have lower GRMs, indicating room for potential growth and possibly higher yields in terms of rental income a property makes.
An investor's strategy also plays a role in determining an attractive GRM. For example, an investor seeking a long-term appreciation might be more tolerant of a higher GRM in a promising area, anticipating future rental increases and rental property value appreciation. In contrast, someone looking for immediate cash flow might prioritize a property with a lower GRM, suggesting a quicker return on their investment. They ensure that the asking price of the property is calculated well.
To effectively use GRM for rental properties, it requires an understanding of the context in which it is applied. Here are some scenarios when you can use GRM for rental properties.
One of the primary ways to use the GRM is for comparing properties within the same market or neighborhood. If you're considering multiple properties within a city or a specific district, the gross rent multiplier can help quickly identify which properties offer a better return based on their purchase price and potential rental income.
When negotiating the purchase price of a property, you can use the gross rent multiplier or GRM formula to serve as a reference point. If one property has a significantly higher GRM compared to similar properties in the area with low GRM, it might be overpriced. Using this metric, an investor might be able to negotiate a lower purchase price and identify whether a property is a good investment or not.
GRM can also help investors gauge market conditions over time, not only the value of a certain property. By tracking the average GRM of properties in a particular area over months or years, you can get insights into how the market is evolving.
A property's gross rent multiplier that is steadily increasing might indicate a market where property values are rising faster than rents, which could signal an overheating market. Conversely, a declining GRM might point to increasing rent values or softening property prices.
You can also use GRM to guide your rental pricing strategy because you'll learn about the value of a property in simple calculations. If you're buying in an area with a high GRM, it might be worth exploring ways to increase the property's rental income, perhaps through property enhancements or targeting a different tenant demographic.
If a condo in a trendy urban area has a high GRM due to its premium price, making luxury upgrades might allow you to ask for higher rents which can improve the GRM, price, and gross over time. Investors and real estate brokers easily calculate the rate of return of a rental or the profitability of a property by identifying the average GRM in the area.
The Gross Rent Multiplier, as previously discussed, offers a high-level overview of a property's potential value by comparing its market price to its gross rental income. By determining how many years it would take for the rental income to cover the value of your income-producing properties, GRM provides a quick way for investors to assess and compare properties. The gross rent multiplier also serves as a basis for rental strategies as mentioned earlier.
On the other hand, the Capitalization Rate dives deeper by incorporating a property's Net Operating Income (NOI). The Cap Rate is calculated by dividing the NOI (which is the gross scheduled income minus all operating expenses) by the property's purchase price or current fair market value of a property.
In essence, the Cap Rate offers a percentage that represents the annual return on investment if the property was bought outright with cash. This is particularly useful because it gives a clearer picture of the property's profitability by accounting for operating expenses.
While both Cap Rate and GRM provide valuable insights, they offer different perspectives. GRM focuses on gross rental income related to property price, giving a quick, initial assessment tool. In contrast, the Cap Rate dives into the property's actual profitability after considering expenses.
When it comes to the Gross Rent Multiplier (GRM), there are several notable advantages and disadvantages you should know to make better-informed decisions. Check them out below.
The GRM focuses specifically on rental income and is calculated by dividing the property's price or market value by its gross annual rental income. It gives an idea of how many years it would take for the rental income to cover the property's value.
On the other hand, GIM or gross income multiplier considers the entire gross income of a property, not just from rent but also from other income sources like laundry facilities, vending machines, or parking fees. GIM is calculated by dividing the property's price or market value by its gross annual income. It offers a broader view of the property's income potential relative to its price.
Yes, the Gross Rent Multiplier (GRM) and Cash-on-Cash Return differ. While you can use gross rent multiplier to get a high-level view of the number of years it would take for a property's gross rental income to cover its purchase price, Cash-on-Cash Return is a measure of the annual return the investor makes on the property in relation to the amount of mortgage cash they invested.
It is calculated by taking the annual pre-tax cash flow and dividing it by the total cash invested.
The Gross Rent Multiplier (GRM) and the 1% Rule are not the same. The 1% rule is a rule of thumb that suggests that a property's monthly rent should be at least 1% of its purchase price. For example, a property priced at $200,000 should ideally bring in a monthly rent of $2,000.
The GRM, on the other hand, is a tool that tells you how many years it would take for a property's gross rental income to cover its market value or price. The formula to calculate GRM is just one of many metrics you can use for your real estate investments.
The Gross Rent Multiplier (GRM) is an essential tool in real estate, offering insights into a property's potential value in relation to its rental income. However, as we've discussed in this blog, it's evident that no single “good” GRM value fits all scenarios.
That said, use GRM to estimate the profitability of the property, but always be prepared to go deeper to ensure that your real estate ventures are both informed and strategic.
Ready to assess a property with the GRM formula? Locate the best rental properties by reaching out to us! Here at Property Leads, we offer exclusive seller leads to help you get ahead of your competition.
Fill out the form below to get started!