If you want to make sure a potential rental property has serious earning power, you’ve probably come across GRM, or the gross rent multiplier formula before. The GRM is used in real estate as a quick way to evaluate a property’s money-making potential. But what exactly is the gross rent multiplier, and how do you use it? While you may already be using GRM, there are some things you may never have considered before.
What Is the Gross Rent Multiplier (GRM)?
The gross rent multiplier is a simple way to assess a property’s profitability compared to similar properties in the real estate market. It’s used by real estate investors because it’s a simple formula that can be used to quickly assess if it’s a good investment. When calculating GRM for a property, know that it won’t replace more in-depth ways of assessing property value but it will give you a quick snapshot before you take a deeper dive.
How to Calculate GRM
The formula for GRM is simple and there are many different times when it’s beneficial to use it. In this article I’m going to focus on the top three ways I like to use GRM. The first is when determining the sale price of a property, the GRM is the list price of the property divided by the gross annual actual rents. For example, if a duplex is listed for $1,000,000, and the gross annual rent income is $50,000 ($25,000 for each unit), the GRM is $1,000,000/$50,000 = 20. Therefore, the GRM of the duplex is 20. In instances where the GRM is not a whole number, it’s common to round up or down and eliminate any decimal points.
What is a Good Gross Rent Multiplier?
The lower the number the better the GRM, because first of all it indicates a better rental income to price ratio. If you purchased a building for $1,000,000, would you rather earn $50,000 (20 GRM) or $65,000 (15 GRM) in annual rental income? Of course, it’s better to earn $65,000 in which case the building has a GRM of 15 instead of 20.
When purchasing a property, the GRM is also a rough estimate for how long it will take you to earn back the cost of the property. If your GRM is 20, that means that it will take roughly 20 years for the rental income to add up to the purchase price of the building. In actuality, it will take less than 20 years if you raise the rent consistently each year. Ultimately, the less time it takes you to recoup your investment cost, the better.
Another rule of thumb is that in general, the more units there are in a building, the better the GRM. One of the reasons for this is because on average you will be paying less per unit. It’s like when you buy toilet paper in bulk volume at Costco compared to buying a single roll of toilet paper at 7-Eleven. A pack of 30 rolls from Costco will cost more upfront, but you end up paying less per roll compared to buying an individual roll.
Why Would You Buy a Property with A Higher GRM?
Typically, rental properties that are in better condition have a higher GRM which means that as an investor, the tradeoff is lower cash flow for the benefits of a higher quality property that has features such as new double pain windows, upgraded kitchens and bathrooms, newer roof, and a well maintained exterior. While, in the short term, the nicer property with the higher GRM means you will have less cash flow, in the long term you will likely save by not having to pay for unexpected repairs, deferred maintenance and eventually updating the interior by adding the contemporary upgrades that renters at every price point are seeking.
Location can also have an impact on the GRM. Properties in more desirable neighborhoods tend to have a higher GRM, however the advantage is that they also tend to attract more qualified renters so the unit will likely rent out quicker when there is a vacancy.
Location can also be important if you plan on managing and maintaining the property yourself. Owning a property that is located somewhere that is convenient for you might be worth the trade-off of having a higher GRM.
Using GRM When Buying
The second way to use GRM is when you are purchasing a property. It’s a great way to do a quick calculation to decide if a property matches your investment criteria, and to compare it to other properties on the market. This can help you determine which property to purchase and/or how much you want to offer for a property. The other thing to consider when purchasing a property is the pro-forma rent (the fair market value rent if the current rents are below market) to see if the property has unrealized potential to have a better (lower) GRM by raising the rents.
Getting Your Annual Check-Up
Every year I go to the doctor to get my annual health check. Similarly, I like to use GRM once a year to assess how all my properties are performing by estimating what the current market value of my properties are and dividing that number by the annual gross rent to see if the GRM has gone up, down or remained the same from when I first purchased the property. In our current real estate market, property prices have been going up on average 10-15% per year for the past few years, which could have an effect on your GRM if your rents are not keeping pace with the market – which is most likely the case due to statewide rent control laws. In some cities, even though real estate prices increased significantly, government restricted landlords from raising the rent due to the COVID crisis.
If you find that your property value has greatly appreciated, yet your rental income has been increasing at a much slower rate or even worse you haven’t raised the rent in years, this is a good time to re-evaluate your investment and decide if you want to raise the rents each year to the maximum allowable amount (typically 5% + CPI), or sell the property while values are high and either cash out or do a 1031-exchange.
GRM is only one factor to consider when evaluating a rental property, and there are three different times I like to use it – when determining the sale price of a property, the purchase price of a property and once a year for evaluating how a property is performing. There are many other factors that need to be taken into consideration when evaluating investment real estate. Calculating the GRM is a quick and easy first step. If you would like a free GRM cheat-sheet, you can download one from the blog section of my website or I’m happy to email it to you directly.
I’m interested to know what’s most important to you when purchasing an investment property. Feel free to contact me with your thoughts and questions. It’s my mission to help you build wealth one door at a time. If you would like a free comprehensive financial analysis of your rental properties, I’m happy to provide one for you.
Mercedes Shaffer is an agent with Pacific Sotheby’s International Realty and specializes in investment real estate and 1031 Exchanges. For help with buying or selling investment property, Mercedes can be reached by phone at 714.330.9999, by email at [email protected] or visit her website at www.InvestingInTheOC.com. DRE 02114448.