If they want to be successful, rental real estate investors have to do a lot of homework. All potential rental investment properties should be thoroughly analyzed before an offer to buy is made. Often, an REI evaluates multiple investment opportunities simultaneously. Is there a quick way to rank which of these opportunities might be the best potential buy candidate? Actually, there is.
Applying the Gross Rent Multiplier (GRM) formula in purchase evaluations is a quick and straightforward way to get meaningful, albeit limited, comparisons between potential rental property investment opportunities. Here’s how it works.
A GRM can be calculated either monthly or annually, but using annual numbers is usually more helpful. The equation is simple – take the rental property’s market value and divide it by gross rental income.
Let’s run through three quick examples:
House Value #1 – $440,000
Annual Rental Income – $2,500 per month X 12 or $30,000 per year
GRM – $440,000 divided by $30,000, or 14.6
House Value #2 (A Condo) – $225,000
Annual Rental Income – $1,500 per month X 12 or $18,000
GRM – $225,000 divided by $18,000, or 12.5
House Value #3 – $725,000
Annual Rental Income – $3,500 per month x 12 or $42,000
GRM – $725,000 divided by $42,000, or 17.2
Which property might be the best rental property to purchase? The one with the lowest GRM. Why? The GRM indicates that you’re receiving more rental income in relation to your investment or the purchase price. Now, before you think you’ve found the “Holy Grail” shortcut to sound real estate investment analysis, let’s dive into this a little deeper.
A GRM does not consider other essential factors such as the underlying loan (if any) on the rental property, the estimated maintenance required for the property (how old is the furnace, roof, plumbing, etc.), the neighborhood aspects of the property, and other important factors.
However, what the GRM does tell you is, all other things being equal, where will you get the best return on your investment. A GRM is a very useful tool when comparing houses in a similar price range in the same general area.
Using our three house example, house #2, the condo, will give you a greater return on your investment dollar. But let’s say you don’t want to buy a condo – you may own a couple of them already, you’re not keen on the location, etc. When you compare the other two examples, house #1 and house #3, house #1 is potentially the better deal. Your next step would be to get more details on each house, but assuming they are comparable in required maintenance, loan structures, and all the rest, you would probably buy house #1.
What’s a “good” GRM? There is no such thing as a “good” GRM. Why not? It is a comparative tool only. Property values and rental income vary widely, so an investor doing this analysis in Pennsylvania might get GRMs in the 7 to 8 range, but in New York, they might 12, 14, or even higher. Use this handy tool to compare properties in a similar location and then only as the basis for further research.
Real estate investors often use another tool called a Capitalization Rate, or Cap Rate for short. A Cap Rate calculates property returns by comparing the net operating income (NOI) with the home’s current market value. It estimates how profitable an income property will be relative to its purchase price by considering the property’s operational expenses as well as its vacancy rate.
A GRM is a more limited tool than a Cap Rate, but Cap Rates can be manipulated by over or under calculating costs. Other analyses like cash flow, rental yield, and internal rate of return are helpful. The more research you do (within reason), the more reliable the result.
A GRM is a reliable starting point and also a rough type of grading system. It really comes in handy when evaluating five or more properties in a similar price range in the same general area. Used as a filter, a GRM rank can guide you toward drilling down on only two of the five properties rather than spending time, and some cash, thoroughly investigating all five.
Are you considering purchasing a residential real estate rental property in Westchester County? At Sterling Property Solutions, our team can answer all of your property management questions and address any challenges. Please give us a ring at 914-355-3277 or send us an email at firstname.lastname@example.org.