Beginning with the right tools and applying a deliberate strategy within your investment search towards a future acquisition of an asset can help avoid many of the most well-known mistakes that befall new investors.
One way you can conserve time while searching for assets and recognize potentially beneficial properties for your portfolio is by promptly totting up the Gross Rent Multiplier of particular communities and, as an aggregated total, across various neighborhoods, cities, or even entire states.
What is a "Gross Rent Multiplier"?
Gross Rent Multiplier (GRM) is an uncomplicated property income-producing analysis formula used by investors to scrutinize, access quickly, and analyze investment properties inside an asset portfolio.
The distinction between the GRM and other systems is that it singularly uses the gross scheduled income (GSI) comparative to a building's price/value to screen the property/portfolio. The metric is rudimentary in real estate analytics and is practiced chiefly as a suggestive screening tool rather than a definitive value indicator.
GRM's ratio of the subject property's price to its gross rental income. Gross rent multiplier (GRM) is used to predict multi-unit and commercial income-producing real estate investments. It uses the building's price, divided by the gross rents, to reach a ratio that may be scrutinized and matched up with comparable investments in a similar market.
The GRM formula is as follows:
GRM = Price / Gross Annual Rent or Gross Scheduled Income (GSI)
Based on the formula above, the GRM is calculated by dividing the fair market value of a property or the property's asking price on the market for sale by the estimated annual gross rental income. This implies that asset revenue numbers are available. If the seller does not produce an actual rent roll, you'll need to do some market research to feel better about the average asking rents at properties relative to the asset in question.
Keep top of mind that the GRM won't predict the amount of time it will take to pay off the property because other factors drive that period, not least of which is the responsibility for meeting obligations that lessen available resources to amortize the expense of purchasing a building. The gross rent multiplier also does not account for any debt used to buy the property.
Let's say an investor plans to acquire a multi-family rental property for $35 million with a monthly gross rental income of $360,000. The asset generates another $3,000 monthly in ancillary income, such as through valet trash NOI generated from an on-site, third-party vendor. Therefore, we need to multiply $363,000 ($360,000 + $3,000) by 12, which comes out to $4,356,000 in rent annually.
Gross Rent Multiplier = Property Price / Gross Scheduled Income (GSI) = $35 million/$4,356,000 = 8.03
So, we have found that the GRM for this property is 8.03.
The GRM is deployed only as a benchmark for comparing one property against another. Professional developers typically look at so many communities that they need to apply rapid screening tools to determine worthy additional investigation. Other metrics like price per square foot, the cost per unit, rent per square foot, and the like need to be kept top of mind.
What is a "Good" Gross Rent Multiplier?
This number varies depending on several factors. The most crucial to be conscious of is that it will progressively decline as the market cycle expands and property prices rise. Inevitably, as the market rises from a recession, the GRM will typically be comparatively low as investors return to acquiring properties as liquidity starts to come back into the flow. High single-digit GRMs may be the norm in such circumstances.
As the period lengthens and cash for investment becomes more immediately available, both from lenders and equity investors, values grow quicker than rents, and the GRM goes up – conceivably into the teens.
An unwritten rule is the lower the GRM, the more conceivably lucrative the deal. Class B and Class C assets in secondary or tertiary markets will ordinarily have a flatter GRM than Class A properties or assets established in primary, core markets.
Recollect that whenever you run the Gross Rent Multiplier formula, it is crucial to remember to check all operating costs before pulling the trigger on an asset. The fact that a property has a low GRM does not indicate that it is a sure thing. Operating costs, like utilities, management, maintenance, repair costs, vacancies, and other expenditures, are critical in evaluating whether a property is profitable and has investment potential. Factors including late & non-payment to vendors can have positive impacts on this number.
Investors are compelled to weigh apples to apples when studying at GRM. For example, examining a Class C industrial building's GRM to a Class A apartment building's GRM is not especially beneficial, principally if these assets are located in different markets. Instead, use GRM to counterbalance comparatively similar holdings in the comparable condition in similar markets.
Why is the Gross Rent Multiplier Important?
One of the most definitive steps in the commercial real estate investment process is distinguishing between properties to determine how much time and means to designate more in-depth research around investment opportunities. Commercial property appraisals are very different from residential, and there is an abundance of factors that go into favoring a property. Property comparisons are much more challenging when you have to worry about building expenses and maintenance and dealing with the vagaries surrounding rental income, raises, resident concerns, and all else that arises with operating a thriving commercial asset.
GRM enables you to swiftly analyze two comparable properties, which may vary in various locations, or have different characteristics, justifying additional quantification using other, more well-defined, comparison methods. As such, it is an invaluable way to preserve time while searching for investment properties; instead of delving into the financials of each parcel a sponsor comes upon, they'll discover the Gross Rent Multiplier swiftly and efficiently, helps make swift decisions on whether to look closer or to pass.
Conclusion
There are reasonable grounds to adopt a Gross Rent Multiplier to assess potential commercial properties. The utilization efficiency makes even the most amateur investors employ this approach to their advantage, with limited risk of creating errors with more complicated formulas. The time gains reached by GRM are also exceptional, it only requires a few seconds to learn if a property meets your GRM terms, and you can use the technique with communities, counties, cities, or whole states.
However, this metric should be applied in combination with additional similarly broad and connotative ratios such as rent per foot, the price per foot, gross per unit price, etcetera, to ascertain if anything seems out of variance with a property type and location. Once an asset has been vetted by these 'blunt' estimations and opportunities identified, the more advanced evaluation techniques commonly used in advanced feasibility studies will help investors develop a sharper picture of their potential investments.
Still, some fancy Cap Rate, considered more stable and reliable due to its consideration for the operating expenses and the income property's vacancy rate, making it a more well-defined assessment of its actual performance.
The Gross Rent Multiplier is a useful scanning tool for the investor in recognizing where opportunity may lie. When utilized with an assortment of other similarly broad, indicative metrics, it helps distinguish properties worthy of more in-depth investigation.