August 17, 2016
By David Saba
Gross Rent Multiplier (GRM) is a capitalization method that is used for measuring the approximate value of a commercial property (that produces income) depending on the gross rental income of the property. In simpler words, it is a method to calculate the approximate value of an investment property. The GRM measures a ratio between the gross scheduled income of the rental property and its true value. Although it is not quite simple to calculate, because it ignores the occupancy levels and expenses of operation; it is still considered to be one of the most reliable measurements for comparing two or more properties. GRM is particularly useful in those areas where the operating cost is likely to be uniform across several properties. It helps in selecting and then comparing the different investment properties for detailed analysis.
Gross Rent Multiplier is widely used for calculating the value of a commercial property by using GRM approach to valuation. The value of a property can be deciphered by multiplying the GRM with the gross rent which is obtained from the property. It is particularly useful for selecting and comparing those properties where the different periodic costs, depreciation effects and the costs incurred by a particular renter is either expected to be uniform across varied properties or insignificant when compared to the gross rental income.
In order to calculate the GRM of a property you will have to divide the value or the selling price of a property by the gross rents of the given property. In order to get an idea about the GRM of a particular property and location, it would be better to consult a local commercial appraiser or a real estate agent.
For instance, if the selling price is $200,000 and the gross monthly rents is $2000, then the GRM of this property would be $200,000/$2000 which is equal to 100.
Again the value of this property would therefore be $200,000. The value is calculated by multiplying the annual gross rent which is $2000 and the GRM which is 100.
The income generated from an investment property is called the rent. To make things simpler and in order to compare the properties better, we can make all the figures annual here. The gross income would be the total annual rent which is expected to be paid. This is also termed as the gross schedule income as it already assumes that the investment in most cases in rented. Many investors check the value of the gross rent in relationship with the price for getting a ratio called the gross rent multiplier. GRM is generated when the value or price of a property is divided by the gross rent.
Let us now come up with an example of a single family that has a property valuing up to $100,000. The rent of this property is $1000 per month, which makes it $12,000 per year.
The GRM= Value/price of the property/ gross rent
8.33 = $100000/ $12000
This can now be compared to properties that are either on the market or have been already sold. For investors, the lower the GRM is, the better would be the relationship between the price and the rent. In simpler words, when each of the multipliers is lower, then the investor is likely to get more rent for the value of each dollar. This would further suggest a considerably higher return in the income. However, this is more of a 'rule of thumb' approach of looking at the property as it never takes into the account the complete reality of the investment. For instance, in a stable and proper neighborhood, the properties might be rented for a long time even with fewer turnovers, compared to a neighborhood that comes with a lot of challenges.
Limitation- It is not an accurate measurement
The Gross Rent Multiplier is somewhat limited and should not be used in your investment decisions. It is only tool that should be used as a quick preliminary calculation. GRM does not take into account expenses. It is almost impossible to accurately ascertain price without knowing the expenses. Due to variation in costs between different properties, you may see one commercial property with a Rent Multiplier 01 10 and another one with a GRM of 5.Because it is not likely that one of those commercial properties is a good buy and the other one is a horrible buy, the difference is perhaps due to a big difference in expenses. Keep in mind that older buildings have more expenses so they are likely to sell for lower prices. This may considerably affect the rent multiplier.
An excellent alternative to the GRM measure would be the net investment measure. However, despite the benefits of using the latter method, most investors choose to use GRM as this is particularly useful for selecting and comparing those properties that are a subject to periodic costs, depreciation and the costs to a specific investor incurred by a prospective renter. These costs are quite difficult to measure using the Net investment approach; due to which most investor opt for the GRM method.
Although GRM is easy to calculate, it is not a very precise method for estimating value. Nonetheless, it is a good quick value assessment method to determine if further analysis is needed. In other words, if the Gross Rent Multiplier is way too low or high compared to comparable commercial properties, it perhaps signifies gross over pricing or a problem with the commercial property.
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