Editor: As many of you know, my wife and I have been growing our real estate knowledge this year. We want to help you do the same as you consider whether to enter this potentially lucrative area of investment. Peter shares his thoughts in today’s Saturday Selection, originally published on Passive Income MD.
As real estate investors, we’re always on the lookout for the next great deal. You never know when one might come up; it could be online, through a sponsor, or in a simple conversation with a real estate savvy friend.
Of course, not every deal is a good one, and sometimes it’s easy to spend a lot of time researching a deal before finding out that it’s not a good fit. I wouldn’t call that time “wasted” necessarily, but it is time you could have spent on something more beneficial.
Understanding how to do the proper due diligence is absolutely essential. However, as an initial screening method, it’s good to have a great grasp of rules of thumb.
This is where the Gross Rent Multiplier (GRM) can come in handy. It’s a great way to weed out purchases with low return potential and help identify some good ones.
Today, we’ll be taking a look at just what this metric is and how it can be useful for real estate investing decisions. Let’s get right to it!
What is Gross Rent Multiplier?
The Gross Rent Multiplier (GRM) calculation is simply a property’s purchase price divided by its gross yearly income.
GRM = Property Price/Gross Annual Rental Income
Basically, when you calculate the GRM of a property, you’re getting a simplified way to evaluate the property from an income perspective. It gives you an idea of how long it will take before the property begins to pay for itself.
For example, let’s say that you’re eyeing a property listed for $400,000. That property currently brings in $4,000 per month in rent, giving us a gross annual rental income of $48,000.
$400,000/$48,000 = 8.33
With this quick estimate, we can see that it will take roughly eight years before the property is paid off. Obviously, the lower the number, the better.
Of course, since this is a gross calculation, it doesn’t take into account any expenses you may run into (we’ll get to that in a moment).
The GRM alone can be a nice tool for determining how much of a financial commitment an investment will be, time-wise. But there are a few other ways it can be used, which leads right into the next section.
How to Use Gross Rent Multiplier
First, it’s important to note that the GRM is only a quick estimation to be taken with a huge grain of salt. It can be very useful for getting the general idea of whether a potential investment is worthwhile, but not much more.
With that said, there are some ways that the GRM sheds some light on other calculations, which can also be very useful.
First, it can be used to find the fair market value of a property. After determining the GRM for a particular property, the calculation is this:
Market Property Value = Rental Income x GRM
Going back to our previous example, simply take the rental income ($48,000) and multiply it by the GRM for similar properties in the area. The GRM you use could be from a single property, or from an average. Let’s say you’ve determined the average of several properties in the area to be 9.75:
48,000 x 9.75 = 468,000
This gives us a typical property value of $468,000. So, in this case, the original example could indicate a very good deal, because it’s quite a bit below the typical property value.
The second way to use the GRM would be to determine what a fair rent should be for a certain property. Let’s say that you’ve found a property that seems like a good purchase, but you aren’t sure how much rent it could generate. If you’re able to determine the GRM from a similar property in the same market, you can use it to get a general idea of what the rental income could be. Here’s the formula:
Fair Market Rent = Property Price / GRM
If you’re looking at a property with a purchase price of $375,000 and other, similar properties have a GRM of 9.75, the calculation would look like this:
$375,000 / 9.75 = $38,461 (Monthly: $3,205)
This can give you an idea of how much income you could expect a property to generate, given how similar properties in the area are performing.
GRM can be great if you’re looking for long-distance properties, by the way, because it gives you a good overview of the area’s market. By doing that, it can help you narrow down those markets with better investment potential very quickly.
What Gross Rent Multiplier Doesn’t Account For
As I mentioned before, all of these calculations only give a very generalized idea of a property and its surrounding market. After all, the GRM is only an estimate of gross rent, and so doesn’t account for any expenses you’ll see as a landlord.
This may include taxes, property management, maintenance costs, repair costs, insurance, depreciation, and more.
So, as long as you take GRM with the aforementioned grain of salt, it can be a great tool for estimating and screening potential properties.
I absolutely believe 2021 will be a huge year for real estate investors.
Whether you’re scoping out a nearby market or looking at one across the country, the Gross Rent Multiplier can be a fantastic metric for making those first-stage decisions.
Of course, it’s always good to reiterate that the GRM shouldn’t be the only metric you use in making those decisions, but sometimes we just need a quick rule to let us know whether a certain property or market is worth pursuing.
Do you use the GRM when scoping out new investment opportunities? Let me know in the comments below! I’d love to discuss it with you.