Understanding gross rent multiplier as an investment tool

When you want to buy an investment property, you have a lot to think about. You must determine the best neighborhood, the schools available to renters, and the rental vacancies. You’ll also compare investment property portfolios.

Don’t forget the gross rent multiplier! Adding this invaluable tool to your investment property checklist will help you better understand the opportunity available within a location you’re considering.

What is Gross Rent Multiplier (GRM)?

The gross rent multiplier (GRM) is a screening metric used by investors to compare rental property opportunities in a given market. The GRM functions as the ratio of the property’s market value over its annual gross rental income.

Keep in mind that GRM isn’t equivalent to the length of time it takes for the investment to pay off because it doesn’t include the full net operating income (NOI). Additionally, GRM isn’t the only calculation available to measure a profitable investment.

GRM vs. capitalization rates

GRM often gets compared and contrasted with capitalization rate and net operating income.

A capitalization rate (real estate cap rate) compares the return on commercial real estate properties by dividing the property’s NOI by its property asset value. NOI determines revenue and profitability after subtracting necessary operating expenses.

While all of these metrics are important to consider, GRM offers a more efficient method to quickly evaluate investment properties compared to cap rate or NOI.

How to calculate Gross Rent Multiplier

This simple formula shows you how to calculate the GRM for a rental property:

Gross Rent Multiplier = Fair Market Value ? Gross Rental Income

Example: $200,000 Fair Market Value ? $24,000 Gross Rental Income = 8.3 GRM

The GRM formula compares a property’s fair market value to its gross rental income. As you can see in the formula example, the payoff period occurs in just over 8 years.

Other expenses, such as repairs to the unit, vacancy rate, property taxes and homeowners insurance don’t become a part of this calculation. GRM is just one metric that helps you make an accurate decision between comparable properties without taking these other expenses into consideration.

What is a good Gross Rent Multiplier?

A “good” GRM depends heavily on the type of rental market in which your property exists. However, you want to shoot for a GRM between 4 and 7. A lower GRM means you’ll take less time to pay off your rental property, which means it will likely be more profitable.

But remember, it depends on the particular real estate market that you're buying. A GRM of 7.5 for a particular investment property might not seem “too high” depending on the market.

How to use GRM in real estate investments

Once you calculate your GRM using the provided formula, you can compare GRMs with similar properties. Let’s say you compare one potential real estate investment, which has a GRM of 6. Other properties in the area might have a GRM of 8 or 10. In this case, you might want to choose the property with the GRM of 6 because it might offer a profitable investment opportunity.

Also, you can use GRM to predict property values in a specific market. In other words, you can use known GRMs of area properties, if you know them, to get a sense of the fair market value of that property.

Consider this: you know that the average GRM of several properties in the area is 6 and the properties generate about $25,000 of cash flow per year. You could estimate what the fair market value of another property in the area should be. The GRM calculation in that case would look like this: $25,000 ? 6 = $150,000.

How to use GRM to calculate rental income

You can use GRM in yet another way – to calculate the gross rental income. Let’s say you know a property value sits at $150,000 and the average GRM in the area is 6, you can divide the fair market value by the GRM to get the total amount of rental income you can expect to receive, like this: $150,000 ? 6 = $25,000.

If you only know the GRM and the gross rental income, you can use the GRM formula to calculate the property value. Simply multiply the gross rental income by the GRM: $25,000 X 6 = $150,000 property value.

Manipulating these types of formulas lets you create your own grading scale for evaluating investment properties in a particular market and allows you to get savvier about what metrics you should look for before you buy.

Potential downsides of using GRM

GRM is an easy way to quickly compare similar properties in the same market, which is particularly useful for new investors. However, it has its drawbacks.

The GRM formula doesn’t factor in operating expenses, like maintenance, taxes, insurance and utilities, which can impact the property’s profitability. It also doesn’t consider vacancy rates and assumes full occupancy. It doesn’t paint a complete picture of a property’s potential income and doesn’t consider property condition or appreciation potential.

There are additional methodologies similar to GRM, capitalization rate and net operating income. There’s also net income multiplier (NIM), which is similar to GRM but it accounts for operating expenses, and effective gross income multiplier (EGIM), which adjusts for vacancy, concessions and other non-rental income from the property.

The bottom line: GRMs are a quick investment opportunity ranker

Ultimately, GRM offers a sorting tool to give real estate investors a way to make decisions. Lenders view the income and profitability of a property through the lens of GRM real estate as one of the most important lending qualification factors.

You should consider property conditions, repair estimates, operating costs and cap rate to decide if an investment property has the potential to make a profit. GRM doesn’t offer the final word on whether you should or shouldn’t invest in a property, but it does offer a great starting point.

Have you found a profitable investment property and want to take the next step? Start the mortgage application process today with Rocket Mortgage®.