Real Estate Investment Terminology (Part 2)

This is the second installment in an ongoing series of discussions of terminology utilized in the realm of investing and specifically in reference to investing in real estate.  For this installment we will be focusing on the term gross rent multiplier or “GRM”.

The gross rent multiplier is a computation of the gross rent that a property generates in relation to its acquisition cost.  The formula for the gross rent multiplier is as follows

Gross Rent Multiplier equals acquisition cost divided by the gross annual rent.

For example a 10 unit apartment has 10 2 bedroom apartments that rent for $1400 each.  Gross monthly rent is 10 times $1400 which equals $14,000.

Annualize the gross monthly rent by multiplying by 12 (12 X $14,000 =$168,000)

Acquisition cost for the building is $1,800,000.

$1,800,000 Divided by $168,000 equals 10.7.

The Gross Rent Multiplier (GRM) is 10.7.

Let us supposed the acquisition cost is $2,400,000

$2,400,000 divided by $168,000 produces a Gross Rent Multiplier (GRM) of 14.3

What is the significance of the gross rent multiplier?
The gross rent multiplier is most effectively used a means of comparing different investments and calculating sales trends.  Utilizing data collected from actual closed sales one is able to establish what investors were willing to pay for a property in relation to what kind of gross revenue it generates.

To put this in perspective would you prefer to pay $1,800,000 for a property that generates $168,000 or would you prefer to pay $2,400,000 for a property that generates $168,000?  Buyers prefer a low Gross Rent Multiplier (GRM) while a seller seeks to achieve the highest Gross Rent Multiplier (GRM) possible.

It is important to keep in mind that the Gross Rent Multiplier (GRM) only concerns itself with income and does not take into account any expenses. The challenge of incorporating expenses into the analysis by utilizing the capitalization rate formula is that often times the expenses reported by the seller can differ drastically from what a new buyer would incur.   For example the property taxes for an owner who purchased 20 years with a basis of $250,000 assuming at 1.25% tax  rate results in property taxes in the amount of $3125.  If the same property is sold and reassessed at $800,000 the new property taxes are $10,000.

Utilized properly the Gross Rent Multiplier (GRM) can be an effective tool when analyzing potential investments.