What’s the gross lease multiplier (GRM) and the way is it helpful for traders?
As real estate investors, we are always looking for the next big offer. You never know when you might show up; It can be online, through a sponsor, or in a simple conversation with a real estate friend.
Of course, not every deal is good, and sometimes it’s easy to spend a lot of time researching a deal before finding out that it doesn’t fit well. I wouldn’t necessarily call that time “wasted,” but it’s time that you could have spent on something more useful.
Understanding how to do proper due diligence is absolutely essential. However, as a first screening method, it is good to have a good understanding of the rules of thumb.
This is where the gross rent multiplier (GRM) can be useful. This is a great way to weed out low return purchases and identify some good ones.
Today we’re going to look at what this metric is and how it can be useful in making real estate investment decisions. Let’s get to that in a moment!
What is the gross rent multiplier?
The calculation of the gross rental multiplier (GRM) is simply the purchase price of a property divided by its gross annual income.
GRM = property price / gross rental income
Basically, when calculating the GRM of a property, you have a simplified way of evaluating the property from an income perspective. You will get an idea of how long it will take for the property to pay for itself.
For example, let’s say you have your eye on a property that is listed for $ 400,000. This property is currently bringing in $ 4,000 per month in rent which brings us an annual gross rental income of $ 48,000.
$ 400,000 / $ 48,000 = $ 8.33
With this quick estimate, we can see that it will take approximately eight years for the property to pay off. The lower the number, the better.
Obviously, since this is a gross calculation, it doesn’t take into account any costs you may encounter (we’ll get back to that in a moment).
The GRM alone can be a good tool for determining how much financial commitment an investment will be in time. However, there are a few other uses that lead straight to the next section.
Use of the gross rent multiplier
The first thing to note is that the GRM is just a quick estimate that can be made with a giant grain of salt. It can be very useful for getting a general idea of whether a potential investment is worth it, but not much more.
With that in mind, there are a few ways the GRM can shed light on other calculations, which can also be very useful.
First, it can be used to find those fair market value a property. After determining the GRM for a specific property, the calculation is as follows:
Market property value = rental income x GRM
Going back to our previous example, just take the rental income ($ 48,000) and multiply it by the GRM for similar properties in the area. The GRM you are using can come from a single property or from an average. For example, let’s say you have the average of several properties in the area at 9.75:
48,000 x 9.75 = 468,000
This gives a typical property value of $ 468,000. In this case, the original example could indicate a very good deal as it is well below the typical property value.
The second way to use the GRM is to determine what a fair rent should be for a specific property. Let’s say you’ve found a property that seems like a good buy, but aren’t sure how much rent it could generate. If you are able to determine the GRM from a similar property in the same market, it can give you a general idea of what the rental income could be. Here is the formula:
Fair market rent = property price / GRM
If you look at a property with a purchase price of $ 375,000 and other similar properties with a GRM of 9.75, the calculation looks like this:
$ 375,000 / $ 9.75 = $ 38,461 (monthly: $ 3,205)
This can give you an idea of how much income you can expect from a property, given how similar the properties are in the area.
By the way, GRM can be great if you are looking for distant properties as it gives you a good overview of the area’s market. This allows you to very quickly narrow down the markets with better investment potential.
What the gross rent multiplier does not take into account
As I mentioned earlier, all of these calculations only give a very general idea of a property and its surrounding market. After all, the GRM is only an estimate of the gross rent and therefore does not take into account any expenses that you as a landlord see.
This can include taxes, property management, maintenance costs, repair costs, insurance, depreciation, and more.
As long as you’re taking GRM with the above grain of salt, it can be an excellent tool for assessing and reviewing potential properties.
I firmly believe that 2021 will be a huge year for real estate investors.
Whether you’re exploring a nearby market or checking out one across the country, the gross rent multiplier can be a fantastic measure of these early stage decisions.
Of course, it’s always good to repeat that the GRM shouldn’t be the only metric you use to make these decisions, but sometimes we just need a quick rule to let us know if a particular property or market is worth it to pursue.
Are you using the GRM to explore new investment opportunities? Let me know in the comments below! I would like to discuss it with you.