Investing in rental properties can be a great way to generate a passive income stream. A key part of the puzzle is identifying properties that have the potential to be profitable. That’s where knowing how to calculate gross rent multiplier or GRM comes in as it can help you better manage and profit from any potential rental property. A financial advisor can also help you create a financial plan for your real estate investing needs and goals.
What Is Gross Rent Multiplier?
The gross rent multiplier measures the ratio between a property’s market value and the gross rental income it’s expected to generate over the course of a year. It’s just one measure investors can use to gauge the profitability of an investment property.
The gross rent multiplier formula allows you to make comparisons across similar properties in the same rental market, using gross annual rental income as the core factor. In other words, it’s a tool for determining how much a rental property could potentially be worth to you, should you choose to invest in it.
How Do You Calculate Gross Rent Multiplier?
It’s easy to calculate the gross rent multiplier using two aspects of a rental property. Here’s what the gross rent multiplier formula looks like:
Gross rent multiplier = Fair market value/Gross rental income
Fair market value simply means the property’s price or what it’s expected to sell for. A good way to determine whether a property’s fair market value is reasonable is to look at comps for similar rental properties in the same market or area.
Gross rental income is simply the rent you collect from a property over the course of a year. It does not include deductions for any operating expenses or mortgage expenses associated with the property.
Here’s an example of gross rent multiplier calculations. Say you want to buy a property that’s priced at $210,000. Based on comparable rentals in the area, you believe that you can generate $30,000 in gross rental income per year. If you divided the property price by its gross rental income, you’d get a gross rent multiplier of 7.
By itself, that won’t tell you much. For that reason, it’s helpful to know how to interpret gross rent multiplier calculations.
What Is Gross Rent Multiplier Meant to Tell You?
The gross rent multiplier is designed to tell you what kind of return you can expect on a property investment. It can be a useful metric to use for making comparisons between different properties in the same area to find investment opportunities that are likely to yield the most value to you.
By itself, the gross rent multiplier may not be that informative. Figuring out that a property has a GRM of 7, for instance, is only part of the picture. The gross rent multiplier becomes more useful when you’re evaluating several properties at once.
For example, say you’re looking at rental properties in an up-and-coming neighborhood. You run the math and find a handful of properties with GRMs in the 4 to 5 range. Meanwhile, the majority of properties in the area have gross rent multipliers that are closer to the double-digit range.
As a general rule of thumb, a lower GRM is preferable as it indicates that you’ll have a higher margin for returns on your investment. It’s important to remember, however, that the gross rent multiplier isn’t the only factor to consider when weighing property investments as it doesn’t factor in expenses or mortgage costs.
What Is a Good Gross Rent Multiplier?
There’s no absolute cutoff for what constitutes a good or bad gross rent multiplier. Again, it’s better to look for one that’s lower versus one that’s higher. Generally, it’s a good idea to aim for a GRM of 10 or below. Anything over that number could suggest that the property is likely to be a financial sinkhole for you, in terms of profitability. If you have a property with a higher GRM, you may need to raise the rent in order to reduce it.
Whether that’s realistic or not can depend on the temperature of the rental market in your area. If rents are already trending upward, then you may not have any difficulty increasing rental rates and attracting or retaining tenants. On the other hand, if rents have largely stabilized then a significant increase could make finding tenants who are willing to pay your price more challenging.
What’s the Difference Between Gross Rent Multiplier and Cap Rate?
A rental property’s capitalization rate or cap rate is a measurement of its rate of return. The difference between the gross rent multiplier and the cap rate lies in how they’re calculated.
To calculate a real estate cap rate, you’d divide the property’s net operating income (NOI) by its value. To find net operating income, you’d add gross operating income and other income generated by the property together, then subtract the property’s operating expenses.
The gross rent multiplier can be used to estimate value, based on the property’s gross rental income each year. With a cap rate, you’re trying to figure out what the property should be worth based on the net operating income.
It’s important to know that NOI does not include any debt service on a property. In terms of whether it’s better to calculate GRM or cap rate, they can both yield important information to investors. However, the gross rent multiplier may be easier to calculate if you don’t know a property’s NOI.
Pros and Cons of Using GRM to Evaluate Real Estate Investments
Gross rent multiplier can offer insight into rental properties but like anything else, it’s not perfect. As an investor, it’s important to know what you can get out of this formula and where it falls short.
On the pro side, GRM is easy to calculate. It’s a very simple, fast formula you can use to compare rental properties. You can easily use it to identify properties that might have the most potential when it comes to turning a profit, without having to dig into the specifics of the property itself.
The biggest drawback of using a gross rent multiplier is that it doesn’t take operating expenses or debt service into account. Finding a property with a low GRM could be misleading if the costs of maintaining it are high. The gross rent multiplier formula also doesn’t account for vacancies, which can short-circuit the property’s cash flow temporarily.
The Bottom Line
It’s important to do your research before making an investment in a rental property to ensure that your expectations for profitability are in line with the kind of returns you’re likely to realize. Calculating the gross rent multiplier can be a good place to start when evaluating which properties might be the best fit for your portfolio. It can give you a snapshot of your potential to earn income after you close on the transaction.
- Consider talking to your financial advisor about how to evaluate real estate investments if you’re interested in owning rental properties. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When you invest in a REIT, you can collect dividend income passively without having to worry about managing properties firsthand. Real estate crowdfunding allows you to pool money with other investors while leaving the management of the property to someone else. Finally, you might consider exchange-traded funds (ETFs) or mutual funds that concentrate their holdings on real estate investments.
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