Gross Rent Multiplier VS. Capitalization Rate
Back when I worked at the appraisal firm in the early 2000s we used to perform tons of residential appraisals throughout Orange County and Los Angeles. Many of the appraisals were of residential income properties for various lenders. One approach to determining a properties value is by use of the income approach. This approach employs the gross rent multiplier or GRM.
GROSS RENT MULTIPLIER
A gross rent multiple is the sales price of a comparable property divided by the estimated market rent for a property.
Sales price / gross rent (1 year gross rents) = GRM
Many investors use the GRM as a reference when comparing investment properties as a way to determine if the property has good value from an income perspective.
Historically there is a rule of thumb that one should buy a property with a GRM at 10 and sell at 20. This is just a guide and there are other factors that can be at play, such as employment, economic growth, inflation and wage inflation. Also, more desirable areas will have a higher GRM due to the expected appreciation. There is another accepted way of determining GRM which is typically used in appraisals and that is using the same formula but with a monthly gross income instead of yearly. You can use that when talking to your appraiser buddies but for the most part, the rest of the world uses the yearly income version.
Another way many investors calculate whether an investment is the correct investment for them is by using a capitalization rate or Cap rate. This takes things a little further and factors in the expenses. In short net operating income divided by the sales price.
Net operating income / Sales price = Cap rate
This was considered to be more accurate because of differences in expenses such as taxes, licensing, management and maintenance. The problem with this is that the expenses can be manipulated. Capitalization rates can be manipulated because expenses are subjective especially when co mingled with capital expenditures. The bottom line is that it is more difficult to corroborate Capitalization Rate than GRM.
Many brokers and owners still prefer using GRM as a way to value income property because the numbers can be confirmed with a rent roll.
There are many areas that are experiencing increasing rents. If you would like assistance in purchasing rental property or owner occupied properties please contact me.
Mat Just BRE# 020241287
Douglas Elliman Real Estate