What’s it take to be remembered forever? A good name? A well-worded turn of phrase? In the case of Henry Wadsworth Longfellow, probably both: There’s nothing in this world so sweet as love, And next to love the sweetest thing is hate! When it comes to the Gross Rent Multiplier, all financial students must learn: there is nothing sweeter to hate.
Weâ€™ll start with the benefits of the GRM: itâ€™s easy.Â The Gross Rent Multiplier is simply the ratio of price to gross rents!
GRM is a quick estimation of investment value, often considered a â€œback of the napkinâ€ calculation, however when dealing with multi-million dollar investments, it is absolutely essential to understand all risks involved, and GRM falls very short of a due diligence calculation. Â As investors/consultants/brokers/very-near-future-moguls we must reconsider the words of Walter Capital, and make every investment a smart investment. Thatâ€™s not to say donâ€™t take risks, in fact quite the opposite! Risk is our reward, but you must be smart about it.
Solely relying on Gross Rent Multiplier is like jumping out of a plane and hoping your backpack doubles as a parachute, and not the other way around.
The following example is GRM in practice:
If you have a 10 unit apartment building where all tenants pay $1,000 per month, and the market dictates the Gross Rent Multiplier should be around 10 times the gross rent, then the estimated value of the building is $1,200,000. See Below.
But, and this is a big butt (erâ€¦but), Gross Rent Multiplier does not account for any operating factors.Â Although itâ€™s easy to love a high or low GRM (depending on where youâ€™re standing: buyer or seller), GRM is often misleading and therefore a manipulative ratio.
GRMâ€™s macro look at a property does not account for the following examples of operating factors: vacancies, regulations, operating expenses including taxes, insurance, utilities (all of which can vary widely from property to property)â€¦ how old is this place?â€¦ how safe is this place?… where is this place again?… to name a few. Â Any of these factors can skew the actual value of a property greatly.
Assume you are given the opportunity to invest in Property A with gross rents of $140,000 per year and Property B with gross rents of $120,000 per year. Both properties will be sold for $1,200,000.Â If we base our decision solely on Gross Rent Multiplier, Property A with a GRM of 8.57 ($1,200,000/$140,000) sounds like a better investment than Property B with a GRM of 10.00 ($1,200,000/$120,000).Â Letâ€™s add a few variables before we make our wise decision:
Yes, Property A has the better GRM (10.00), but Property B is far more efficient when it comes to operations of the property; efficient enough to overcompensate for the $20,000 lesser Gross Potential Rent.Â By factoring in Property Bâ€™s efficient expense ratio (35%) and vacancy rate (5%), youâ€™ve just got a better investment; and imagine that, the CAP RATE (6.18%) sums it up nicely.Â Weâ€™re glad you didnâ€™t base your decision on the Gross Rent Multiplier but returned to the highly useful Cap Rate.
So never let anyone say â€œI told you so,â€ because you back of the napkinâ€™d a GRM!Â Instead take two minutes to educate yourself on a property, itâ€™ll pay off in dividends (or $2,490 per year if you run into this example â€“ for two minutes?Â We donâ€™t even charge that much).
To assist you in your continuing growth out of Freshman status and up to speed with the big leagues, I have included a FREE GRM calculator and matrix. Â Play with the numbers, learn it, love it (I mean hate it), and then forget it, reallyâ€¦