The realty market is sensitive and capable of yielding either good profits or causing heavy losses to anybody who's involved in it. Any involvement in realty requires that you analyze the market scientifically and have a fair knowledge about it.
There are quite a few ways to evaluate your investment property, some of them are:
- Gross Rent Multiplier (GRM)
- Income Capitalization Rate (Cap rate)
- Cash-on-cash Rate of Return
Of these, the GRM is a simple and quick way to decide whether a property is worth considering as an investment. It is at the most, only a rough and ready estimate and is certainly not the best way to assess your property value. The GRM is an indicator on whether any further analysis and research is needed on your property value. By itself, it is not a robust measurement. GRM finds its place in realty analysis by virtue of being a quick way to decide whether it is worth expending further time and effort in assessing the property for further investments.
What is Gross Rent Multiplier?
It is the ratio of the price of an income producing property to its gross annual income.
How is Gross rent Multiplier calculated?
GRM is calculated by dividing the market value of the property by the gross scheduled income. Gross scheduled income is the maximum amount of annual rental income obtainable from a property (at 100% occupancy).
To illustrate with an example -
A property has a market value of $475,000 and a gross scheduled income or annual gross income of $80,000. The GRM for this property would be $475,000/$80,000 = 5.93.
Suppose a property is in the market with an asking price of $840,000 and with an established annual gross income of $100,000. The GRM of comparable properties, which have recently been dealt in the market, is 6.2. To find out if the property is worth investing in, the reasonable market value for this property can be arrived at.
GRM * Annual income = Market Value
6.2 * $100,000 = $620,000
Thus at the asking rate of $840,000, it may not be a wise decision to invest in this property.
While the decision for investment is being taken, this GRM should only be used to evaluate this property when compared to similar properties. Therefore, a lower GRM presents a more attractive investment prospect than a property with a higher GRM.
In a scenario where the depreciation rate, recurring costs like taxes and insurance, operating expenses are consistent and trivial in relation to the gross income across similar properties, the GRM ratio is a good measure. When GRM is calculated using the effective gross income, i.e. annual potential income less vacancy value, then it becomes a much more reliable indicator.
While the GRM is a convenient tool of measurement because of its simplicity, it is limited in use, as it does not take into account factors like credit loss, vacancy, operating expenses etc.