As you build a real estate portfolio, a few simple calculations can help you save time and energy as you search for properties to fit into your goals. The gross rent multiplier is one of the formulas that could accelerate the process of sifting through potential investment opportunities.
Today we will take a closer look at the gross rent multiplier formula and walk you through how this calculation could be useful as you build your portfolio.
What is the gross rent multiplier?
The gross rent multiplier (GRM) is a number that can be useful to evaluate the investment potential of a property. As a real estate investor, you can use the calculation to compare different investment property opportunities.
The GRM compares the gross annual rent from a property with the fair market value. It is important to note that the gross rent multiplier doesn’t factor in any expenses related to maintaining the property or the costs of financing the purchase.
Although there are some limitations to the metric, it can offer a quick assessment of a property. That can offer a useful way to sift through several investment opportunities quickly. If you have a specific multiplier in mind, you can avoid spending too much time on real estate deals that don’t meet your expectations.
With a helpful tool like the gross rent multiplier metric in your back pocket, you can quickly and confidently eliminate properties that don’t suit your investment goals.
What is the GRM formula?
Here is the gross rent multiplier formula:
Gross Rent Multiplier = Property price/ Gross Annual Rental Income
The property price should reflect the fair market value of the investment. The gross annual income should encompass the rental income you expect to receive from the property each year.
How do you calculate the gross rent multiplier?
The process of calculating the gross rent multiplier is fairly straightforward. Here are the steps you’ll need to take:
What is the gross annual rent?
Before you can accurately calculate the gross rent, you’ll need to determine the property’s gross annual rent. You may be able to obtain the actual monthly rental income from the seller. But if not, you can do some research on the area to determine a fair monthly rental price.
Once you have the monthly rental income of a property, simply multiply that number by 12 to arrive at the gross annual rent.
Here are a few examples to help you understand the gross rent multiplier formula.
Let’s say you are considering purchasing a property in cash at the fair market rate of $100,000. Based on information from the current owner, you know that you’ll be able to charge $1,000 per month in rent.
First, determine the gross annual rent. In this case, you would simply multiple $1,000 by 12. That leads to a gross annual rent of $12,000. Next, divide the property price of $100,000 by the gross annual rent of $12,000. With that, you’ll end up with a gross rent multiplier of 8.33%
Let’s say you’ve come across a property in cash that has a fair market rate of $500,000. The current owner is unwilling to share the current rental income of the property. With that roadblock, you decide to do your own research to find what rental rates the market could support. After research, you’ve learned that the property can potentially bring in $4,000 in rental income each month.
First, determine the gross annual rent. With this example, you would multiple $4,000 by 12. That would lead to a gross annual rent of $48,000. Then, divide the property price of $500,000 by the gross annual rent of $48,000. You’ll arrive at a gross rent multiplier of 10.41.
Limitations of the gross rent multiplier
As you’ll notice from the examples above, the formula doesn’t factor in a variety of points that could increase or decrease the profitability of the deal.
The first limitation is that the gross rent multiplier doesn’t consider the expenses required to maintain the property. If you are dealing with constant repairs, that will put a dent in your bottom line. A second limitation is that the gross rent multiplier doesn’t consider any of your financing costs. If you are taking out a loan to fund a property’s purchase, the loan charges will impact your overall return on investment.
Although there are some limitations, the gross rent multiplier is still a good metric to use as a starting point as you compare properties.
What is a typical gross rent multiplier?
A lower gross rent multiplier will indicate a more lucrative deal. However, the higher reward may also come with higher risk. On the flip side, a higher gross rent multiplier will indicate a less financially rewarding deal. With less reward, you’ll likely find lower risks.
As with most things in real estate, the typical multiplier will vary widely based on your local market. You’ll have a better understanding of a typical gross rent multiplier in your area after working through the calculation on a variety of properties.
You can also factor in your personal risk tolerance for your portfolio as you sort through potential properties. If you want to remain a low risk investor, then you might tend to invest in properties with higher gross rent multipliers.
When should you use this?
This formula is an easy to calculate figure that can help you evaluate the potential profitability of a property. With that, it is a good number to use when considering different investment properties. The number will allow you to determine which of the properties is the better deal at a surface level.
Once you’ve used this quick back of the envelope calculator, that shouldn’t be the end of your research of the property. Instead, the gross rent multiplier should act as a starting point. After that, you should look at other factors of the deal before moving forward.
A few other factors to consider include the cap rate of the properties, your financing opportunities, the property’s condition, and more.
The bottom line
This can help you sort through potential real estate deals. Armed with this knowledge, you can evaluate potential real estate investments quickly and effectively.
Luckily this is not the only metric that you can use to evaluate properties. Another useful number is the cap rate which takes things a step further and includes the expenses of maintaining a property in the calculation. Additionally, the 1% rule can help you weed out deals as you scan the listings.
Don’t be afraid to use a combination of these metrics to evaluate potential investment properties. Use these calculations to determine whether or not a deal is worth investigating further. Then continue to conduct your due diligence until you are comfortable moving forward with a property.