What is the Gross Rent Multiplier in Commercial Real Estate?
In commercial real estate investment, one of the most important contributors to the total return is the price paid to purchase the property. But, a property’s market value can be subject to interpretation and is often dependent upon the accuracy of assumptions made about income and expenses well into the future. In addition, a full discounted cash flow analysis can be time consuming and could cause an investor to miss a great opportunity.
To address this issue, commercial real estate investors occasionally use a valuation metric that is fast and easy to calculate and can be used to compare different property types. It is known as the Gross Rent Multiplier (GRM).
Gross Rent Multiplier – Defined
Gross Rent Multiplier is a valuation metric that seeks to determine how the price of a property compares to the amount of Gross Rental Income it produces.
How is Gross Rent Multiplier Calculated?
The Gross Rent Multiplier formula is: Property Price / Gross Rental Income. Understanding the origin of these variables can provide additional insight into the intuition behind this metric.
The price of the property could be represented in one of several ways. It could be the listing price from the broker, the asking price from the seller, or the appraised value. Or, if none of these values are known, it could be an estimate of value at the time the metric is being calculated. The point is, the numerator doesn’t necessarily have to be the purchase price, but it does have to be some representation of the property’s estimated value.
In the denominator, Gross Rental Income is the estimated amount of income that the property produces in year 1 of the proforma. This estimate is informed by the property’s rent roll, income statement and any potential adjustments due to market conditions at the time the metric is calculated.
For example, assume that a property has an asking price of $1,000,000 and the projected Gross Rental Income is $100,000 in the first year of ownership. This means that the resulting GRM is 10 ($1,000,000 / $100,000).
But, What Does The Gross Rent Multiplier Mean?
By itself, the Gross Rent Multiplier doesn’t mean much. However, it becomes incredibly useful when compared to the Gross Rent Multiplier for other, similar properties.
For example, suppose an investor is trying to decide between the purchase of two comparable properties in the same market. They are both shopping centers with similar ages and similar tenant bases. However, one property is much larger than the other so a direct price comparison can be difficult. Property #1 has an asking price of $6,250,000 and it is projected to produce $590,000 in gross rental income in the first year of ownership. Property #2 is much smaller and has an asking price of $3,750,000 and a projection of $180,000 in gross rental income. The GRM for each is as follows:
Property #1: $6,250,000 / $590,000 = 10.59X
Property #2: $3,750,000 / $180,000 = 20.83X
What does this tell the investor? When comparing the two investment properties, it tells them that property #2 is far more expensive per dollar of gross income produced relative to property #1. Put another way, of the two, property #1 offers a better value even though it has a higher purchase price.
What is a Good Gross Rent Multiplier?
Like many commercial real estate metrics, there is no Gross Rent Multiplier that is considered objectively “good.” Instead, the power of the Gross Rent Multiplier can be seen when it is compared to other properties. In this light, the general rule of thumb is that a lower GRM represents a better value and higher return potential.
Gross Rent Multiplier & The Due Diligence Process
The Gross Rent Multiplier is used early in the due diligence process and it is most useful as an initial screen.
For example, suppose an investor has identified 5 commercial properties that look promising for a potential investment. If they were to calculate the Gross Rent Multiplier for each of them, they could quickly filter out the properties whose valuation is not commensurate with the others. With the GRM, perhaps they are able to narrow the choices to two properties for which they can calculate detailed valuation metrics like the capitalization rate (Cap Rate) and Net Operating Income (NOI).
What is the Difference Between The Gross Rent Multiplier and The Cap Rate?
Although cap rate and GRM are both property valuation metrics, they are in fact distinctly different.
The Cap Rate is based on the amount of Net Operating Income (NOI) that a property produces. As such, it is calculated net of operating expenses like property taxes, insurance, and utilities.
Gross Rent Multiplier is calculated using gross annual rental income, which does not incorporate operating expenses. In fact, this is one of the arguments against using GRM as a real estate valuation technique. It does not account for operating expenses or vacancy, which are important components when determining the value of a property.
Conclusions & Summary
In commercial real estate investing, the Gross Rent Multiplier is a valuation metric that is calculated as the property’s purchase price divided by its projected gross annual rent in year one.
In isolation, the Gross Rent Multiplier does not provide much information, but it can be powerful as a comparison tool between potential acquisition targets and as a tool used to screen potential properties out of consideration.
Interested In Learning More?
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If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.