Gross rent multiplier is the total annual potential rent divided into the value of the real estate property. The gross rent is used without accounting for any of the other operating expenses such as taxes, utilities, maintenance & repairs, property management fee, etc.
The purpose of the gross rent multiplier is to allow an investor who may be considering several properties to make a quick, initial evaluation of the deal. Knowing the gross rent multiplier for other properties in a given market area will allow an investor to make a rough estimate of the property under consideration. The gross rent multiplier becomes the number of years it would take to pay for the collateral using the gross revenue. A higher GRM of 10-12 would represent a worse investment opportunity than a GRM of 6-8.
The numbers required to calculate it are easy to obtain. Real estate agents will often know the general GRM values for a given market area. It may allow an investor to quickly eliminate a poor investment without digging too deeply into other factors.
Since the GRM does not take into account any of the operating expenses it offers an incomplete evaluation of the property. Issues of whether the landlord or tenant pays for certain expenses such as utilities will greatly affect the value of the property. A vacancy allowance is not accounted for in calculating the GRM. There is no universal means of evaluating the GRM value of a property. A GRM of 7 might be a good investment in one neighborhood and a poor investment in another. Clearly one must have a feel for the GRM of similar properties in the same market area.
Gross Rent Multiplier=Selling Price/Gross Annual Potential Rent
Example: Selling Price-$1,000,000 Gross Annual Potential Rent-$100,000
Value=GRM x Gross Annual Rent
GRM for the area and property type – 8 Annual Rents – $50,000
Value estimate=8 x $50,000=$400,000
In looking at the value calculation above, if the asking price were $600,000 it might be a good idea to pass on this one.