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, the rental vacancies and more. You’ll also compare investment property portfolios.

Don’t leave the gross rent multiplier off your checklist!

Never heard of the term “gross rent multiplier”? That’s OK. We’ll teach you why you want to add this invaluable tool to your investment property checklist.

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.

In other words, let’s say one property collects $2,000 in rent and another property collects $1,200 in rent.

You want to determine how much rent you will collect relative to the property cost. If both properties cost $200,000, the property that rents for $2,000 will give you the most return on your investment. However, this changes if the property cost changes. You can use GRM to make a determination.

Note: GRM is not equivalent to the length of time it takes for the investment to pay off because it doesn’t include the full net operating income. GRM does not represent the only calculation you should use to measure a profitable investment.

Let’s take a look at the gross rent multiplier formula. This 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 insurance don’t become a part of this calculation. However, GRM is just one metric that helps you make an accurate decision between comparable properties without taking these other expenses into consideration.

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.

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

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 net operating income (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.

Let’s flesh out how to really use GRM.

Once you calculate your GRM using the provided formula, you can compare GRMs with similar properties. For example, 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.

You can also 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.

For example, let’s say 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.

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.

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.

Ultimately, the 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 criteria.

The 1% rule is another commonly used tool in the decision-making process. Along with the GRM, it offers a sorting tool to determine whether a property makes investment sense.

Among other factors, you also need to consider property condition, repair estimates, operating costs, cap rate and more 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.