How to Estimate ROI by Calculating Your Gross Rent Multiplier
November 25, 2023
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Gross Rent Multiplier And ROI
As a real estate investor, part of your job consists of analyzing deals based on concrete metrics.
One of these metrics is the gross rent multiplier, or GRM. GRM is important because it allows you to estimate your overall return on investment for a property, which is a major factor in its success and your decision to invest in it.
If you’ve never heard of GRM, don’t worry. This article will explain what the metric is, how to calculate it, and how to apply it to properties appropriately.
What is the Gross Rent Multiplier (GRM) Calculation?
The gross rent multiplier is a metric used to evaluate and compare potential real estate investments. GRM is the ratio of a property’s market value to its yearly gross rental income. It functions as a numerical instantiation of one property’s potential over another when they have different market values, starting costs, and potential rental income.
The gross rent multiplier calculation is similar to many other real estate metrics, such as capitalization rate, ROI, and cash-on-cash return. However, while all these metrics are ways of evaluating the success of a particular property, each of them do so from a slightly different perspective, and thus shouldn’t be used interchangeably.
The Gross Rent Multiplier Formula
The gross rent multiplier formula is as follows:
𝐺𝑅𝑀= 𝐹𝑎𝑖𝑟 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑀𝑉) / 𝐺𝑟𝑜𝑠𝑠 𝑅𝑒𝑛𝑡𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒
Let’s take a closer look at each of the components in this formula.
Fair Market Value (FMV)
The top half of the formula is the Fair Market Value, or FMV. This is the price the property would sell for on the open market, or its valuation. According to Investopedia, fair market value generally assumes that both parties are “reasonably knowledgeable” about the asset and are acting in their own best interests.
One important thing to know about FMV is that it differs from regular market value. This is because FMV assumes open market activity—it can’t simply be found on a listing, since prices included in a listing factor in the marketplace. The easiest way to find a property’s FMV is to get it appraised by a professional, who will use various local and federal standards and guidelines to determine an accurate valuation.
Gross Rental Income
The bottom half of the formula is gross rental income. This is the total amount of rental income you receive (or plan to receive) from a property, before making any subtractions for utilities, maintenance, or other operating expenses. Gross rental income differs from net rental income, which is your income after making those subtractions.
The following types of income should be included in your gross rental income:
- The rent
- Any utilities you cover (e.g., trash, water, sewer, electric, etc.)
- Pet rent and nonrefundable fees
- Parking or carport fees
- Gate access fees
- The fair market value of any work a tenant performs on your property
Example of How to Calculate GRM
Now that you understand the individual parts of the formula, let’s calculate GRM for an example property below.
The duplex you’re interested in purchasing is worth $230,000. This is the property’s fair market value. You plan to rent out each unit for $1,230, meaning that over the course of a year (assuming full occupancy), you will generate $29,520 in rental income across both units. For the sake of simplicity, we will say that all other fees (pet rents, parking, etc.) have been included in the rent.
To calculate GRM, plug in the above values into the formula:
𝐺𝑅𝑀=𝐹𝑎𝑖𝑟 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 (𝐹𝑀𝑉) / 𝐺𝑟𝑜𝑠𝑠 𝑅𝑒𝑛𝑡𝑎𝑙 𝐼𝑛𝑐𝑜𝑚𝑒
𝐺𝑅𝑀= $230,000 / $29,520
The gross rental multiplier for this property is around 8.
What is a Good Gross Rent Multiplier
How do you interpret the above result and know what is a good gross rent multiplier for a property?
In general, a GRM between 4 and 10 is considered a “healthy” or strong investment. The lower, the better. However, GRMs need to be considered in comparison to different properties—so in reality, it’s impossible to say how “good” a GRM of 8 is unless you have several other properties with GRMs you can compare it to. The number itself only represents how quickly a property pays for itself in comparison to other properties/investment opportunities.
How to Project ROI with your GRM
Did you know you can use GRM to project your ROI? This section will explain how.
Return on investment, or ROI, is the ratio of the money an investment property generates to the money you originally invested in it. This sounds very similar to GRM, but the key difference is that the top half of the ROI formula (the money the property generates) is the net income, after you’ve paid all bills, taxes, operating expenses, etc. ROI uses “real cash,” or the actual money you have in hand at the end of the day from your properties.
Let’s say you know what a property’s GRM is, but you want to know its ROI. Because the main difference between ROI and GRM is that ROI accounts for operating expenses while GRM does not, the missing information you need is your operating expenses. You can find this out by asking the seller for information regarding the property’s expenses—perhaps a profit and loss statement that lists the property’s monthly expenditures. You can also estimate the property taxes, maintenance costs, property management fees, and other expenses, but it won’t be as accurate.
Once you have a number for operating expenses, subtract that from the gross annual rent you used above for the GRM formula. Let’s take our example from above and imagine that operating expenses for the duplex were around $15,000. Subtracting that from your gross annual rent of $29,520, you get $14,520 of total cash received.
Now we have both pieces you need for the ROI formula:
𝑅𝑂𝐼=𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 / 𝐶𝑎𝑠ℎ 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑
𝐺𝑅𝑀=$14,520 / $230,000
Your ROI for this property would be about 6.3%. In general, an ROI between 7% and 10% is considered healthy, so this property slightly misses that range. However, that doesn’t necessarily mean it’s a poor investment or that you should turn it down immediately—the key is in comparison, as always.
Note: Use rental metrics wisely. Never rely on one metric in isolation to make a decision about a deal or property. Rental metrics work best when considered in coordination with other metrics. This will give you a better picture and perspective of the property.
Experienced real estate investors are masters of manipulating the various factors and components of a deal to evaluate its potential as quickly as possible. Especially when considering hundreds of deals, metrics like GRM and ROI are useful ways to weed out properties and narrowing down the pool to a few you can investigate in depth. By using these two tools wisely and considering them in comparison to other properties and metrics, you can successfully navigate any real estate market.