GRM vs. CAP Rate
by Michael Setunsky
Which method is more viable as a way to value a real estate investment, the Gross Rent Multiplier (GRM) or the Capitalization (CAP) Rate? Let's look at these two methods one at a time and then compare the two.
Gross Rent Multiplier
The GRM also called the Gross Income Multiplier is a very rough "Rule of Thumb" approach to valuing an investment. Webster's New Collegiate Dictionary defines a rule of thumb as a general principle regarded as roughly correct but not intended to be scientifically accurate. In other words the GRM is a ballpark estimation tool for assessing the market value of an income producing property.
Calculating the GRM:
Market Value / Annual Gross Income = GRM
Comparable Sales |
|
Comparable No. | Market Value | Annual Gross Income | GRM |
1. | $800,000.00 | $150,000.00 | 5.33 |
2. | $775,000.00 | $145,000.00 | 5.34 |
3. | $850,000.00 | $160,000.00 | 5.31 |
Median GRM: 5.33
Calculating the estimated Market Value:
GRM x Annual Gross Income = Market Value
Subject Property |
|
GRM | Annual Gross Income | Market Value |
5.33 | $150,000.00 | $799,500.00 |
CAP Rate
The CAP Rate or Capitalization Rate is the rate of return on an income producing property for the first year. Calculating the market value is more detailed using the CAP Rate.
Calculating the CAP Rate:
Net Operating Income (NOI) / Market Value = CAP Rate
Comparable Sales |
|
Comparable No. | Market Value | NOI | CAP RATE |
1. | $800,000.00 | $60,000.00 | 7.50 |
2. | $775,000.00 | $56,000.00 | 7.23 |
3. | $850,000.00 | $65,000.00 | 7.65 |
Median CAP Rate: 7.50
Calculating the Market Value:
Assumptions: Vacancy Rate = 10% - Operating Expenses = 38.62%(1)
NOI / CAP Rate = Market Value
Subject Property |
|
CAP Rate | NOI | Market Value |
7.50 | $75,070.00 | $1,000,933.00 |
GRM vs. CAP Rate
There is more than a $200,000.00 difference between the market value using the GRM and the CAP Rate methods. Notice that GRM does not take into account the Vacancy Rate or the Operating Expenses. These two items can significantly change the market value, as demonstrated above.
In summary, the GRM may be useful for providing a rough estimate of value when initially comparing properties to determine if a more in depth analysis is required. Once you have narrowed down the potential properties, the CAP Rate method should be used for a more accurate analysis.
A final thought. No matter which method is used, the outcome is only as good as the information initially obtained. Strive for initially acquiring accurate and reliable property data prior to completing your analysis.
About the Author: Michael Setunsky is the Broker and owner of Michael's Commercial LLC serving the Northern Virginia commercial real estate market. His more than 23 years of experience as a commercial real estate and business broker has earned him the distinction for being one of the top commercial real estate producers in the Mid-Atlantic Region. He also serves on the Mid Atlantic Real Estate Marketing Association's (MAREMA) Board of Directors, and is a Commonwealth of Virginia licensed Instructor. He teaches Pre-licensing, Post Licensing Education, Broker's and Continuing Education courses. Visit his company web site at http://michaelscommercial.com/.
(1) Operating Expenses derived from median ratio of NOI to Annual Gross Income for comparables.
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Great information Michael!
Debt Coverage Ratio (DCR) and the Cash on Cash Return Rate can be useful too in looking at your potential situation with the rental purchase. There are endless things to calculate but you can improve the rate of return based on appreciation, depreciation, and on your tax bracket. There is a reason why the wealthy (not high income but high net worth) almost always invest in real estate.