Gross rent multiplier (GRM) and return on investment (ROI) can be essential metrics when deciding whether to invest in an investment property. Similar to cap rates and cash-on-cash returns, the following are formulaic ways to determine an investment’s value by comparing different investment variables. The results can be easily compared with other investment opportunities to determine which investment is more valuable to the investor. We will break down what these metrics mean and provide the formulas for calculating these values.
Gross Rent Multiplier
GRM evaluates the value of an investment property based on the price of the property and the gross scheduled annual income, or the total potential income a property could generate if it was fully occupied for the entire year. Gross rent multiplier is the ratio of the real estate’s market value to its annual gross rental income.
The resulting GRM would tell you how many years it would take to earn back the amount invested in the purchase of the property. GRM does not consider any expenses associated with the property, such as property taxes, maintenance, and insurance. Therefore, it should be used as a rough estimate and not as the sole factor in determining the value of a property and the time that it will take for the investment to be paid off.
GRM is a very simple and quick calculation that can offer you a comparable potential value of an investment. Use it to compare similar properties without taking other expenses into consideration.
Some negatives about the GRM metric include:
- It’s difficult to assess an accurate value using a calculation that only factors in the initial investment amount and a fully achieving income rate.
- The GRM does not factor in an investment property’s expenses, additional investment contributions that may be necessary, or vacancies.
- The GRM is very limited and will not provide an accurate view of the investment as a whole.
How to Calculate GRM
The formula for GRM is:
Gross Rent Multiplier = Price/Gross Annual Rental Income
In this formula, you can plug in:
- Price: The fair market value of the investment
- Gross annual rental income: The gross rental income of the investment
For example, a property purchased for $500,000 with a gross scheduled annual income of $40,000 would have a GRM of 12.5.
What Is a Good Gross Income Multiplier Value?
There is no one-size-fits-all “good” GRM, as this value varies by the type of asset class and factors such as the location, type of property, and investor-specific goals. However, in general, a GRM below 10 can be considered a good benchmark for most rental properties, as it often suggests you will pay off your real estate investment quicker. A higher GRM could also be acceptable, depending on the market.
Return on Investment
Return on investment compares the money you gain from an investment to the money you initially invested. It’s expressed as a ratio or percentage to measure the potential profit or efficiency of an investment and compare it to other real estate properties. ROI uses the net income of an investment during a certain period of time compared to the investment cost to determine a percentage value of the investment.
The net income is determined by subtracting all expenses and costs from the gross income. Calculate the net income of your real estate investment only after your bills have been paid. Cost of the investment could simply include the original investment price, but could also include any additional contributions made during the course of the investment period.
It is also important to know the period of time for which the income, expenses, and investment costs are calculated. ROI could be calculated as a first-year return or a total return at the termination of the investment.
One negative about the ROI metric is that ROI can be ambiguous if you do not have a clear understanding of all of the factors in the equation. At its best, ROI is used to evaluate investments where there are few transactions, such as the purchase of stock that is sold before any reinvestments are made or any dividends are paid. A stock investment of $100,000 that is later sold for $250,000 has an ROI of 250%. The only problem here is that this does not take the time of the investment into consideration.
How to Calculate ROI
The formula for ROI is:
Return on Investment = Net Income/Cost of the Investment
In this formula, you can plug in:
- Net income: The amount of money yielded from the investment
- Cost of the investment: The amount of money initially invested
For example, a 250% ROI calculated over a seven-year investment would not be as valuable as a 250% ROI calculated over a three-year investment. With a real estate investment where additional contributions are added over time for maintenance or upgrades, late contributions will have as much effect on the ROI as early contributions.
In reality, an investment with a 250% ROI earned off of a $50,000 original investment and a later contribution of $50,000 is more valuable than an investment with a 250% ROI earned in the same amount of time from a $100,000 original investment. Furthermore, financing will affect the actual profitability of an investment but will not factor into an ROI equation.
How Do GRM and ROI Work Together?
The gross rent multiplier formula can be used to project a property’s return on investment in several steps:
- Calculate the gross rental income: Estimate the property’s gross rental income by dividing the fair market value price by the GRM.
- Calculate the operating expenses: Whereas ROI considers the operating expenses of the investment, GRM does not. You must calculate the operating expenses to use the GRM formula and get the ROI. A profit and loss statement can provide an estimate of your income and expense figures. You can also use the 50 Percent Rule — 50% of your gross rental income goes toward operating expenses.
- Calculate your net income: Once you have your estimated gross rental income and operating expenses, subtract the expenses from the income to get the net income.
- Calculate your ROI: Add the net income figure to the ROI formula to determine your return on investment.
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