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.
We’ll start with the benefits of the GRM: it’s easy. The Gross Rent Multiplier is simply the ratio of price to gross rents!
GRM is a quick estimation of investment value, often considered a “back of the napkin” 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. As investors/consultants/brokers/very-near-future-moguls we must reconsider the words of Walter Capital, and make every investment a smart investment. That’s not to say don’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 (er…but), Gross Rent Multiplier does not account for any operating factors. Although it’s easy to love a high or low GRM (depending on where you’re standing: buyer or seller), GRM is often misleading and therefore a manipulative ratio.
GRM’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)… how old is this place?… how safe is this place?… where is this place again?… to name a few. 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. 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). Let’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. By factoring in Property B’s efficient expense ratio (35%) and vacancy rate (5%), you’ve just got a better investment; and imagine that, the CAP RATE (6.18%) sums it up nicely. We’re glad you didn’t base your decision on the Gross Rent Multiplier but returned to the highly useful Cap Rate.
So never let anyone say “I told you so,” because you back of the napkin’d a GRM! Instead take two minutes to educate yourself on a property, it’ll pay off in dividends (or $2,490 per year if you run into this example – for two minutes? We don’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. Play with the numbers, learn it, love it (I mean hate it), and then forget it, really…