Most old-school investors use a simple rule-of-thumb to estimate a property’s value, and this is known as the gross rent multiplier (GRM). The reason for its popularity is that it’s so easy to calculate. Unfortunately, it does not always offer the most accurate or reliable method of estimating the market value for a property. For example, the GRM does not consider such fundamental investment criteria as cost of capital or even operating expenses. Despite its drawbacks, the GRM is a tool that can provide a “quick and dirty” comparison to similar properties in the area.
The gross rent multiplier is the ratio between the market value for a property and its annual scheduled gross income. For example, if the list price for a property is $1,000,000 and the gross rents are $100,000, then this property has a GRM of 10.
The formula used to calculate the gross rent multiplier can also be used in to determine market value:
Market Value / Gross Income = Gross Rent Multiplier
Gross Rent Multiplier X Gross Income = Market Value
When determining the Gross Income, most investors simply find out what are the monthly rents and multiply that amount by 12. Then they multiply the Gross Income using an easy GRM such as 10 to estimate the Market Value.
Investors have their own ideas about what constitutes good value for their investment dollars and how to measure their return on investment. By using two different metrics such as GRM and cap rate, for example, an investor can estimate how much a property is worth relative to similar properties in the area using similar ratios.
On the other hand, given the limitations previously disclosed about these metrics, it is important for an investor to delve more deeply into a property’s operating history and determine its potential upside. The GRM and cap rate might be best-used as screening tools. For example, if a property’s GRM falls in line with an investor’s pre-determined range to consider, then that may warrant further due diligence by the investor and an opportunity for you to offer a more detailed investment analysis. Such an analysis may offer details on tax savings, cash flow forecast, principal reduction, leverage, cost of capital, and future resale value.
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