What is a Gross Rent Multiplier and How to Use it?
Investing in commercial real estate involves finding the best deals as quickly as possible. You need an efficient method of analyzing and comparing potential properties. That’s where the gross rent multiplier (GRM) can come in.
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What is a gross rent multiplier?
How do you know when it is time to take a good look at a commercial property? The answer can lie in the GRM which can also be a useful metric to initially assess a prospective purchase. When used with other ratios, the GRM can be used by real estate investors to compare various properties based on market value and rental income.
The GRM is not the definitive factor for a property’s value, but it is one of the best–and fastest–screening tools available for sorting through commercial real estate opportunities. That is because the GRM is basically a price to rent ratio, two of the easiest figures to determine before performing a more in-depth investigation.
How do you calculate gross rent multiplier?
Calculate the GRM by dividing a property’s purchase price by its annual rental income. The latter is the gross rental income, so leave insurance, property taxes, management and utilities out of the equation.
To accurately calculate the GRM, it is important to include every source of rental income in the calculation. Some properties may have income from non-tenant sources, such as rental of parking lots or storage availability.
For instance, when a $1 million property generates $100,000 in annual gross rental income, it’s GRM is 10. Keep in mind there is no magic GRM number that makes a property a good deal. Acceptable numbers usually range between 4 and 7, vary substantially between asset classes and the stage of the market cycle the analysis is being conducted in, and can only be used to compare the value of similar properties.
Being a very simple metric to calculate and based on gross numbers, the GRM is used as an initial indicator of whether an asset is within the usual range of acceptable numbers.
Location, location, location
What drives a particular GRM number? Much depends on the old real estate mantra – location, location, location.
Of course, similar types of properties must be compared. For example, comparing the GRM of a commercial office building with an industrial site is counterproductive and will not produce useful insights.
Once the GRM on comparable properties is obtained, investors can use it in combination with other ratios to decide which candidate(s) looks like the best investment. This is a prelude to engaging in further due diligence using more refined metrics which will be more time consuming and costly.
What if the GRM is too high or low in comparison with other recently sold comparable properties in the area? That might be a sign the property is overpriced or has some underlying problems and may suggest further investigation is warranted.
Is it better to have a higher or lower gross rent multiplier?
A lower GRM is generally considered better than a higher GRM because it suggests that the price of the property is low relative to gross annual income. Assuming ceteris paribus, with a low GRM, it would take less time to recoup an initial investment and earn rental income from a property with a lower GRM than for one with a higher GRM. In short, a property with a lower GRM will produce returns for investors faster than one with a higher GRM.
Class A properties or those located in top markets will generally have a higher GRM than Class B or C properties in secondary markets. The former will likely have more credit-tenants and will cost more to purchase relative to gross rents than the latter.
A GRM number only makes sense in context. A GRM of 7 does not mean much unless similar properties in the area have a higher GRM. That means a GRM of 7 could indicate investment potential if surrounding comparable properties tend to have GRM’s of 10, for example.
What about properties you already own? The GRM can also be useful here. If the GRM on an asset already owned is higher than comparable properties, it may be because rents are lower than the competitors.
Noticing a lower GRM might suggest that rents can be raised with little risk of losing tenants because they are simply being raised to match market prices. Tenants who do leave will find they are paying comparable rates. New tenants should prove willing to pay the market rent because that is what other landlords are charging.
Again, the GRM is not a definitive tool but an indicative one that is quick and easy to calculate. Looking at an asset and realizing it’s GRM is lower than comparable properties is not, in itself, a greenlight to immediately start increasing rents, but rather suggests further investigation may be warranted.
Gross rent multiplier vs. cap rate
Calculating the GRM relies on gross annual income. Another metric, capitalization, or the ‘cap rate,’ is a more sophisticated calculation that shows the annual expected return on an investment.
The cap rate is based on net return rather than on gross rental income. In real estate terms, it is comparable to the stock market’s return on investment (ROI), as it gauges the property’s income production capacity to its original purchase price or current value. The cap rate reveals the profit percentage of an investment and is more commonly known as an investment’s ‘yield’ in traditional stocks and bonds.
The cap rate provides a more refined evaluation of an asset’s investment potential because it requires greater diligence and effort to calculate including the following:
- The cap rate is determined by dividing the net operating income (NOI) of an asset by its current market value, then multiplying that figure by one hundred to result in a percentage.
- The NOI is calculated by subtracting all operating expenses from the total of all gross revenues.
- Obtaining the operating expenses for a property and calculating the NOI in order to be able to calculate the cap rate of an asset requires a lot more work than simply looking at the gross revenue numbers used in the GRM.
One caveat: Investment real estate is purchased either via loans or cash, or a combination of the two. The cap rate assumes a cash purchase to provide a baseline return. Interest rates, loan repayments or any form of debt service do not play a part in cap rate calculations. Real estate investors take on different amounts of debt, so including loans would not offer an accurate comparison.
While a lower GRM is generally preferable because it suggests a relatively low purchase price, that is not the case with the cap rate. A higher cap rate indicates a higher rate of return or put another way, a lower cap rate means a higher price to purchase an asset.
As with any real estate investment, it is important to dive into the details. A property with a higher cap rate in a less desirable part of town, though producing a higher yield for investors, may not produce the demand of a better situated property and so may struggle during economic downturns. As with GRM, the cap rate is just one factor to consider when deciding between comparable investment opportunities.
Gross rent multiplier vs. gross income multiplier
The gross income multiplier (GIM) can also give a rough idea of an investment property’s value and is more like the cap rate than the GRM because it requires the use of the net-operating-income of an asset to calculate. The GIM is calculated by dividing the net operating income of an asset by the purchase price of that asset.
In this regard it is similar to the price to earnings (P/E) ratio of a stock and serves to provide an initial indication, along with other metrics, of whether an prospective acquisition target is worth further investigation.
None of the metrics discussed so far – the GRM, the GIM, or the cap rate – take into account other important factors in underwriting an asset and determining if it offers potential for the investor. These other factors are considerable and might include:
- The age of a building.
- Population growth.
- Jobs growth.
- Comparable property amenities.
- Deferred maintenance issues.
- Curb appeal.
- Etc.
Using metrics like GRM and GIM which are solely based on price and gross or net annual income respectively, may give erroneous indications by yielding similar numbers even if one property is virtually new and another was built 30 years ago.
How does the gross rent multiplier help you?
The GRM does not exist in a vacuum. It is really only useful for property comparisons and, as a crude metric used in combination with other metrics, serves primarily as a tool for initially screening an asset. Furthermore, the GRM can only be useful when applied to properties that are actually comparable. For instance, properties with similar square footage and rents per square foot in the same area are not interchangeable if one has been well-maintained and the other needs a lot of work.
How the GRM really helps an investor is by prioritizing those properties that appear most promising. A quick metric to calculate, it allows investors to evaluate an asset as part of the ‘price per pound’ initial screening that can weed out properties not worth the while pursuing further.
Gross rent multiplier calculator
As noted, the GRM is calculated by dividing a property’s purchase price by its annual gross rental income. Before making the calculation, the purchase price or fair market value of an asset must be known as does the annual gross rental income. To be able to use the resulting metric, the GRM of similar properties must also be considered.
Below is a GRM calculator.
[Install GRM calculator]
Enter the value of an asset and the gross rent to determine what the GRM is.
What are the best cities for gross rent multiplier?
The pandemic changed everything, and that includes property prices and rents. For investors entering markets more recently, that likely means lower yields and returns than had they entered some years ago. This is to be expected in the growth phase of the real estate cycle as demand for real estate increases, but supply remains relatively short.
That said, with low interest rates and strong demand for warehouses and other commercial properties, there are still plenty of excellent investing opportunities in commercial real estate. At Rising we do not attempt to time the markets, but rather we believe that there are opportunities at all phases of the economic cycle.
While determining what the best cities are to invest in, our search does not start with the GRM. While there is plenty of GRM information available for residential real estate, the metric is less commonly used for commercial real estate. That is why we tend to focus on other metrics, ratios, and drivers to underwrite opportunities. These include population growth, regional economics, and other factors, some of which are listed above.
For example, we look for population growth to identify target cities for investment and in the South and West we see some of the best prospects for real estate investment in the coming years. Texas leads the way, with Houston, San Antonio, Austin, Fort Worth and Dallas increasing by nearly a million people in the past decade. The Lone Star state’s business-friendly climate and low taxes also make it a top choice for commercial real estate investing.
Phoenix, Arizona is another strong contender. Like much of Texas, Phoenix has benefited from a massive relocation of Californians seeking a more affordable environment during the pandemic. That population growth bodes well for the commercial real estate market.
Other Western cities with strong growth patterns that we like include:
- Los Angeles, California
- Orange County, California
- San Diego, California
- San Francisco, California
- Sacramento, California
- Portland, Oregon
- Seattle, Washington
- Denver, Colorado
- Salt Lake City, Utah
- Boise, Idaho
- Las Vegas, Nevada
Regionally, the South’s largest cities have grown faster than any other areas of the U.S. Besides those in Texas, Jacksonville, Florida, Atlanta, Georgia, Nashville, Tennessee and Charlotte and Raleigh-Durham, North Carolina have experienced large population gains.
The asset type we are looking at will also play a major role in where we would look to acquire as well. In office investments, for example, we look for assets that are typically in amenity-rich urban environments with mass transit access and a sophisticated tenant base near a large, affluence and educated workforce. Multi-tenant light industrial assets, on the other hand, might have a location that’s adjacent to a major urban city where there’s access to an educated talent pool, close to workforce housing but is slightly more affordable, among other things.
Other metrics to consider
Although the GRM is still useful when it comes to commercial real estate investing, metrics such as cap rates, the internal rate of return (IRR) and the cash-on-cash return provide more specificity and need to be used to together to paint a fuller picture of a particular asset’s investment potential.
The internal rate of return (IRR) measures real estate returns over time and considers the time value of money, allowing investors to evaluate and compare different acquisition prospects more accurately. While similar to the return on investment (ROI), the IRR is by no means identical. The ROI can be used to calculate the state of an investment at any given moment in time whereas the IRR takes into account all investments in an asset no matter when made, all income streams, and projects compounded returns over time.
The IRR can also be used to measure performance of an investment retroactively by considering all payments made at any point in time to investors, relative to those investors’ total investments made in the asset.
The ROI is more commonly used to indicate performance based on what has already taken place, whereas the IRR is commonly used to project returns in the future and to calculate net present value of an asset against targeted return hurdles.
While like the cap rate, cash on cash return is calculated post-leverage and looks at actual cash yield of an investment after debt, tax, insurance, and other payments.
Going forward from the gross rent multiplier
The GRM can help make initial decisions regarding property investments but is a blunt instrument and more commonly used in the retail residential investment markets. When we use the GRM at Rising, we only use it in conjunction with other valuation methods. It is just one of the many tools we utilize in evaluating investment opportunities and serves to provide us with an initial screen before engaging in more robust due diligence.
POSTED BY
CASEY HURSH
Casey leads the investor relations team at Rising Realty Partners and is responsible for growing the community of accredited investors, fostering investor engagement, and raising capital.
