How to Use Gross Rent Multiplier (GRM) to Value Rental Properties
Gross Rent Multiplier (GRM) is one of the most popular and effective metrics used to determine the return on investment (ROI) of a commercial or multifamily property. It’s particularly effective at comparing a property’s profitability compared to similar assets in the same market or submarket.
The formula for GRM is:
Gross Rent Multiplier = Property Price / Gross Rental Income
Annual GRM vs. Monthly GRM Calculations: What’s The Difference?
GRM can be calculated either monthly or annually. Traditionally, GRM was calculated monthly, but today, it’s becoming increasingly common for GRM to be calculated annually. For that reason, we will use annual GRM for most examples in this article.
Monthly vs. Annual GRM Example
If a property is selling for $1,000,000 and it produces a monthly Gross Rental Income of $8,000 and an annual Gross Rental Income of $72,000, the monthly GRM would be:
Monthly Gross Rent Multiplier = $1,000,000 / $8,000 = 125
In contrast, the annual GRM would be:
Annual Gross Rent Multiplier = = $1,000,000 / $72,000 = 13.88
How Can I Use GRM to Compare Investment Properties?
In the sample above, the property has an annual GRM of 13.88. Lower GRMs mean that a property has more profit potential, but potentially more risk.
If other, similar properties in the area GRMs of 9 or 10, they would be more profitable investments. For this reason, some investors will have a maximum GRM they are looking for in an investment. Some may, for instance, limit their investment options to properties with GRMs lower than 8.
Investors can also use GRM to value properties, as long as they know the property’s approximate annual income. For instance, if a property has an annual income of $200,000 and local GRMs average about 9, you can estimate the property’s value by multiplying the two.
$200,000 * GRM of 9 = Estimated Property Value of $1,800,000
Conversely, if you know the price of a property, you can use average GRMs to calculate the potential annual rental income the property produces. For example, if a property was valued at $1,000,000 and area GRMs for similar properties are 7, you could divide the price by the GRM to estimate annual rents.
$1,000,000/7 = Estimated Annual Gross Rental Income of $142, 857
Gross Rent Multiplier vs. IRR: What’s the Difference?
Gross rent multiplier is a fast and easy way to compare similar properties. Similar to cap rate, it does not calculate leverage or property value fluctuations in a transaction. Therefore, GRM represents the approximate number of years an unleveraged property will take to fully return an investor’s capital, assuming rents or property values do not change.
In contrast, IRR looks at the estimated annual return of a project over a specified time horizon. Leveraged IRR takes debt, as well as estimated property values and rent increases into account to calculate an investor’s potential return on investment (ROI) over the lifetime of a project.
IRR is calculated via the formula below, though most investors will use a pre-loaded excel sheet in order to quickly and effortlessly calculate the IRR for a specific project.
Where,
t = time,
C = cash flow,
r = internal rate of return, and
NPV = net present value.
Gross Rent Multiplier vs. Equity Multiple
Equity multiple is another common metric that’s used by many real estate investors. In many ways, equity multiple is closer to IRR than to cap rate, as it looks at the ROI over the life of a project rather than taking a static snapshot of a property’s potential return.
Equity multiple looks at the total amount of equity an investor puts into a project vs. the amount of money they take out of it.
The formula for equity multiple is:
Equity Multiple = Total Profit + Max. Equity Invested / Max. Equity Invested
Like IRR (and unlike GRM) equity multiple can be calculated in a levered or unlevered fashion. Unlike IRR though, the return is not discounted over the period of investment/investment horizon. An equity multiple of 2 in a 12 month period would be incredibly impressive; an equity multiple of 2 over a 10-year period would not.
Equity Multiple Example:
For example, if an investor bought a property with cash for $1,000,000 including closing costs, they’ve invested $1,000,000 of equity in it. If their profit (which combines all rents and the sale price minus operating expenses and closing costs), equals $2,000,000, they would have an equity multiple of 2, as shown by the calculation below.
$2,000,000 + $1,000,000 / $1,000,000 = 2
Gross Rent Multiplier vs. Cap Rate
Cap rate and GRM are relatively similar types of metrics, as they provide a quick, unlevered snapshot of a potential investment property.
The formula for cap rate is:
NOI = Gross Operating Revenue - Gross Operating Expenses
For example, a property worth $2 million with $100,000 of annual net operating income would have a cap rate of 5%, as shown by the calculation below.
$100,000 / $2 million = 0.05 / 5%
In fact GRM is the inverse of cap rate, meaning that they really are quite similar metrics in calculating the potential profitability of an investment property.
Gross Rent Multiplier vs. Cash-on-Cash Return
Cash-on-cash return is somewhat of a hybrid of GRM and IRR. Cash-on-cash return looks at the cash equity placed into a property, vs. the cash that is received each year, on average, over the life of the investment. Like IRR, it can be calculated as a levered metric, but unlike IRR, it does not incorporate the profit made at the sale of the property (also known as reversion).
Cash-on-Cash Return = Annual Dollar Income / Total Dollar Investment
For example, if an investor placed $500,000 of equity into an investment (with debt or not), and received $50,000 a year in income, the property would have a cash-on-cash return of 10%, as shown by the calculation below.
$10,000 / $500,000 = 0.1 / 10%