I recently sent out a spread sheet designed by someone else ... that had a formula on GRM.
While it is one of many ways to begin due diligence on an potential investment property, I prefer to use a simpler method. I like to calculate using "The 10% rule".
I divide potential annual rent into purchase price. When I started buying Calgary real estate in 2004, I would consider any property that yielded 10% and more. Today, I will consider any property that yields 6% or more.
The Gross Rent Multiplier or GRM is a ratio that is used to estimate the value of income producing properties. The GRM provides a rough estimate of value.
Only two pieces of financial information are required to calculate the Gross Rent Multiplier for a property:
- The sales price
- The total gross rents possible.
If this information is available for multiple recent sales of similar types of income properties in a particular area, it can then be used to estimate the market value of other similar properties in that area.
Some investors use a monthly Gross Rent Multiplier and some use a Yearly GRM.
The monthly Gross Rent Multiplier is equal to the Sales Price of a property divided by the potential monthly rental income and the Yearly GRM is the Sales Price divided by the yearly potential rental income.
Example: If the sales price for a property is $335,000 and the monthly potential rental income for a property is $2,100, the GRM is equal to 160.
Monthly potential rental income is equal to the full occupancy monthly rental amount which assumes all available rental units are occupied.
Generally speaking, properties in prime locations, have higher GRMs than properties in less desirable locations.
When comparing similar properties in the same area or location, the lower the GRM, the more profitable the property.
This statement assumes that operating expenses are proportionate for the properties being compared.
Since the GRM calculation doesn't include operating expenses, this statement might not hold true for similar properties where one of the properties has significantly higher operating expenses.
A market GRM can provide a rough estimate of value, but it does have some limitations. The GRM calculation doesn't include a property's operating expenses and vacancy factor. We could have a situation where two properties have approximately the same potential rental income, but one property has significantly higher operating expenses. The above formula would result in a questionable estimation of the market value for these properties. Also, the above GRM formula uses the monthly potential rental income and doesn't account for a vacancy factor which could have an impact on the accuracy of the property value estimates. The seasoned investor understands the above limitations and uses the gross rent multiplier to get a quick feel for the potential market value of an income property.
The GRM is sometimes calculated using the effective gross income rather then the potential rental income thus incorporating the vacancy factor in the GRM calculation. Effective Gross income equals potential rental income minus the vacancy amount. When vacancy rates are a factor, using the effective gross income will produce a more reliable estimate.
The capitalization rate is a more reliable tool for estimating the value of income producing properties since vacancy amount and operating expenses are included in the cap rate calculation. The GRM is useful in providing a rough estimate of value.
This info was collected from the website: http://www.invest-2win.com/grm.html