In Part I of Techniques to Speed Up Your Decision Making, I outlined three basic measurements to quickly estimate value of an apartment property.
These three are:
While it’s easy to plug numbers, each technique has its pros and cons. This tutorial’s objective is to help you understand the key advantage and limitation for each measurement.
Exploring Gross Rent Multiplier
We previously explored Price Per Unit. It’s a simple calculation but because income plays no role in the formula, it provides limited insight into the apartment’s investment viability. Gross Rent Multiplier (GRM) is also easy to calculate but unlike Price Per Unit, GRM does incorporate the property’s income.
Gross Rent Multiplier = Price / Gross Scheduled Income (annual)
Gross Scheduled Income is the potential income a property would generate if it was 100% occupied. You can think of GRM as the number of years it would eventually take for the property’s gross income to total the price.
Example: A 10-unit apartment building is offered for sale at $1 million. Each unit is 2Bd/2Ba and is renting for $1,000. What is the Gross Rent Multiplier?
Gross Rent Multiplier = $1,000,000 / (10 x 1,000 x 12) = 8.33 GRM
As long as you can get your hands on the rent roll, then the Gross Rent Multiplier measurement is preferred over Price Per Unit. Generally speaking, properties in prime locations have higher GRMs versus properties in less desirable locations.
Advantage – It’s More Useful and Reliable than Price Per Unit
Pop quiz, what are you buying when acquiring an apartment? You’re buying income stream. Given the fact that GRM accounts for income into its formula automatically makes it a more reliable method for evaluating investment properties compared to Price Per Unit. Additionally, by taking into account income, property features are automatically factored into your evaluation. It’s reasonable to assume that rents reflect unit size, amenities, location, and even external factors such as general market conditions that may add to or deduct from its price level. Rents are market driven – you can only charge as much as a tenant is willing and able to pay. By factoring in a market-driven data point (income), GRM is more reliable as a measurement for comparing properties. In areas where operating costs can be expected to be uniform across properties, GRM is especially useful for comparing and selecting investment properties for further analysis.
Limitation – Ignores Vacancy & Operating Expenses
Gross Rent Multiplier serves to indicate what the market is paying as a multiplier of the gross income. As explained above, gross income is generally a good data point because its market driven and accounts for enhancements and deficiencies of the property as well as general rental demand. But because it is gross instead of net income, GRM fails to differentiate properties with lower or higher operating expenses and vacancies. Tenants may pay for some, all, or none of the operating expense. For example, a landlord may pay for all utilities because the building is master metered. This will result in higher rents compared to an identical property where those costs are directly passed to tenants. If you were estimating the price between the master-metered versus the individual-metered property using the same GRM number, then this would result in a very questionable value.
As with Price Per Unit, it’s important to understand the reason to use Gross Rent Multiplier. Always keep in mind the above limitations and remember that its purpose is to get a quick feel for the potential market value of the apartment.
Photo: Jeramey Jannene