- What is a Gross Rent Multiplier in Commercial Real Estate?
- How To Calculate A Gross Rent Multiplier
- Gross Rent Multipliers Vs. Cap Rates
- How Investors Use Gross Rent Multipliers
- Using Gross Rent Multiplier to Price a Property
- Using Gross Rent Multiplier to Estimate Potential Rents
- 1%/2% Rules Vs. Gross Rent Multipliers
- The Limitations of Using Gross Rent Multiplier For Property Valuation
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What is a Gross Rent Multiplier in Commercial Real Estate?
When it comes to determining whether a commercial or multifamily real estate project is a good investment, there are a variety of methods you can use. One of the most effective is a project's gross rent multiplier, or GRM, in order to help calculate the value of the property. A gross rent multiplier is defined as the number of years a property would take to pay for itself in gross rent without taking into account insurance, property taxes, utilities, and other expenses.
How To Calculate A Gross Rent Multiplier
To calculate a property's GRM, divide a property's sale price by its gross annual rents (which can be estimated using a project's rent roll).
Gross Rent Multiplier = Property Price / Gross Rental Income
For example, a $500,000 property generating $50,000 in gross rental income each year has GRM of 10. A gross rent multiplier is known as a gross income multiplier (GIM), if it adds in other, non-rent sources of income, such as parking or laundry machines (for multifamily properties.)
Gross Rent Multipliers Vs. Cap Rates
A lower GRM typically makes a property more attractive to investors, since it usually pays for itself faster. However, since it doesn't include major expenses, it may not tell the whole story. That's why many commercial real estate investors prefer to incorporate other factors into their valuation decisions, including a project's cap rate. A cap rate, or capitalization rate, uses a project's net operating income (NOI) divided by it's market value to express its estimated rate of return as a percentage.
Cap Rate = Net Operating Income / Market Value
Taking the earlier example, if a property valued at $500,000 produced an NOI of $40,000, it has a cap rate of 8%.
How Investors Use Gross Rent Multipliers
In order to determine an average GRM for a property type in a specific area, many commercial real estate investors like to estimate the GRMs of several properties of the same type in that area and average them. For example, office buildings may have a different average GRM than industrial parks. As a result, it's important for investors to look at the specific type of property they're considering. Once they have a workable average GRM, they can compare it to the GRM of the property they're interested in to see how it matches up.
Using Gross Rent Multiplier to Price a Property
If an investor is considering a property, but thinks that it may be overpriced, they can use a GRM to estimate an appropriate price for the property. This assumes they know the average GRM for that property type in the area and the property's rent roll.
Appropriate Price = Gross Rental Income x Avg. Gross Rent Multiplier
For example, if the average GRM in the area is 8, and the project's annual rent roll is $60,000, the potential price of the property should be around $480,000 (8 * $60,000). When analyzing properties with GRM, it's important to keep in mind that older properties typically have lower GRMs, but can have significantly higher expenses, particularly for repairs and maintenance (R&M).
Using Gross Rent Multiplier to Estimate Potential Rents
On the other hand, if you don't have a project's rent roll, but you want to know what it should be, you can also use GRM to arrive at a ballpark figure.
Gross Rental Income (Rent Roll) = Property Price / Gross Rent Multiplier
For example, if a property is priced at $1 million, and the average GRM for the area and property type is 10, then the property's annual rent roll should be at around $100,000.
1%/2% Rules Vs. Gross Rent Multipliers
While not always accurate, a popular rule of thumb in commercial real estate suggests that an investor can break even if the gross monthly rent of their property is 1% of a property's purchase price, and they can gain a profit if the property's monthly rent is 2% of of the purchase price. This is basically the inverse of GRM, albeit on a monthly basis, not an annual one.
For example, if a property's gross monthly rent is 2% of its purchase price, it has a GRM of 4.16 (0.02* 12 months = 0.24, 100/24 = 4.16). While a property GRM of 4.16 is likely to be profitable, it’s relatively uncommon to find properties with a GRM that low. Because of this, investors should probably take the 1% and 2% rules with a grain of salt.
The Limitations of Using Gross Rent Multiplier For Property Valuation
While GRM can be an effective part of any investor's toolbox when it comes to valuing a property, it doesn't tell the whole picture. Remember, GRM only takes into account gross rents, and doesn't account for taxes, insurance, and operational expenditures (OpEx), which may vary drastically from property to property. That's why it's often a good idea to also look at other factors, such as internal rate of return (IRR) to get a more accurate picture of a property's potential suitability as an investment.