Gross Rent Multiplier: The Rubber Chicken of Commercial Property Analysis
Now a Rubber Chicken is pretty useless … except as a practical Joke. Let’s take a look at the most useless number in Commercial Real Estate.
A $1M property with a $100K annual Gross Potential Income. This property has a GRM of 10. Price (Value) / Gross Potential Income = GRM
$1M / $100K = 10 The GRM number can be thought of as similar to a Price Earnings Ratio for a stock. The Gross Rent Multiplier is the amount of time it would take you to pay for the property if you were actually collecting the Gross Potential Income and putting it towards the property purchase. For our example property: If you were able to collect that hundred thousand dollars a year and you magically devoted all of it to paying for the property … it would take 10 years for you to complete your purchase. Beware of the Gross Rent Multiplier. It can help you compare price between different properties, however, it is absolutely and totally useless as an estimate of value to a returns focused investor. You are focused on the Return on your Investment. You are focused on the Bottom Line. And the GRM is about as much help in understanding your ROI as a Rubber Chicken. ============================= Since the Gross Rent Multiplier only deals with Gross Potential Income, it is flawed for two main reasons.
Whenever you see the term Gross Rent Multiplier … just ignore it. And if a promising property shows up … ask for the rent rolls and the financials and figure out the Net Operating Income as best you can. With the bottom line Net Operating Income and potential price in hand, you will be able to calculate your Return on Investment. With this solid, fact based set of numbers you can make an offer based in reality. Doesn’t mean the Seller will accept it… and at least you start the negotiations with your feet on the ground. To your investing success,
The Gross Rent Multiplier - the Rubber Chicken of Commercial Property Value Indicators.
The Gross Red Multiplier (GRM) is a number you will see on every Broker’s pro forma. And it is touted as a measurement of the “Property’s Value”. If anyone out there really sets a property’s value based on GRM … I have to wonder what they are smokin’. I’m not really sure what a Gross Rent Multiplier measures, but it certainly is NOT the Value of the Property.GRM is calculated by dividing the Property’s sales price or value by the Gross Potential Income.
Example:
A $1M property with a $100K annual Gross Potential Income. This property has a GRM of 10. Price (Value) / Gross Potential Income = GRM
$1M / $100K = 10 The GRM number can be thought of as similar to a Price Earnings Ratio for a stock. The Gross Rent Multiplier is the amount of time it would take you to pay for the property if you were actually collecting the Gross Potential Income and putting it towards the property purchase. For our example property: If you were able to collect that hundred thousand dollars a year and you magically devoted all of it to paying for the property … it would take 10 years for you to complete your purchase. Beware of the Gross Rent Multiplier. It can help you compare price between different properties, however, it is absolutely and totally useless as an estimate of value to a returns focused investor. You are focused on the Return on your Investment. You are focused on the Bottom Line. And the GRM is about as much help in understanding your ROI as a Rubber Chicken. ============================= Since the Gross Rent Multiplier only deals with Gross Potential Income, it is flawed for two main reasons.
1) We’re talking about “Potential Income” based on the Broker’s most optomistic projections of attainable rents. The basic number has no basis in reality - especially if you are looking for a property with upside. Think about it for a second … if the Seller could get these rents for this property they wouldn’t be selling! 2) Gross income starts at the top of the financial statement. For any particular property there is absolutely no relationship between the Gross Income, and the Net Operating Income (NOI) down on the bottom line. You have to know the Real Income and the Real Expenses to understand the actual NOI this property can produce.============================== It is only when you understand the Net Operating Income that you can calculate your potential Return on Investment. Our advice…
Whenever you see the term Gross Rent Multiplier … just ignore it. And if a promising property shows up … ask for the rent rolls and the financials and figure out the Net Operating Income as best you can. With the bottom line Net Operating Income and potential price in hand, you will be able to calculate your Return on Investment. With this solid, fact based set of numbers you can make an offer based in reality. Doesn’t mean the Seller will accept it… and at least you start the negotiations with your feet on the ground. To your investing success,
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Comments (8)
There is an awesome real estate app I use called Realbench that calculates the Gross Rent Multiplier and gives you green or red signals, it also calculates tons of other real estate indicators. You can get it at http://realbench.net, or just go to the Apple Store or Google Play and search for Realbench, in this time and age we don't have to calculate this stuff manually anymore.
Juan Cabrera, about 9 years ago
I like the post, keep it up.
Allen B., over 11 years ago
Bryan Hancock, What is CADS? I am starting out and learning property analysis for a multi-family 6-unit buidling. From what I hav read so far, it's good deal if: Cap Rate: 8+ Cash on Cash Return: 12%+ Debt Converage Ratio: 1.6+
Kumar R, over 11 years ago
CADS - Cash after Debt Service As far as Cap Rate and Cash on Cash determining a good deal... it really depends on the market. For example, getting a 8% cap in Orlando Fl would be good, but in Atlanta GA, would not be very impressive at all. Also, a higher then normal Cap Rate in your market means the sales price is lower then similar properties. The question is, why? You can buy 25%+ cap rates all day long in Detroit, but does that make them good deals? And always make sure you calculate Cap Rate based on actual numbers, not proforma if at all possible. Cash of Cash should be taken the same way as cap rate. It's market specific and needs to be evaluated properly. As for Debt Service Coverage Ratio, most lenders will want to see at least 1.30. 1.6 is very strong and you should not have trouble getting financing, as long as everything else looks good.
Doug Manuel, over 11 years ago
The level of expertise among real estate agents, no mater what initals they have after their names, is pitifully low. Easy bucks, that's what we want!
Truett D. Neathery, Appraiser, over 12 years ago
People want the easied answer, i.e. lowest common denominator. Even if the answer is wrong.
Don Konipol, almost 14 years ago
I never have understood why people use meaningless numbers when it is SO easy to calculate something of significance easily. NOI/2 - Debt Service = (roughly) CADS. Positive CADS good...negative CADS...bad. How is that hard?
Bryan Hancock, almost 14 years ago
Dike, Couldn't agree more. This is the basis philosophy of the CCIM. The GRM is basically a useless rating number with an old and outdated real estate past.
Kyle King, over 14 years ago