The Mortgage Go To Guy!!

When deciding on a purchasing a Real Estate Investment there are several major factors to discuss.

One of them is Asset Class… you may want to invest in Apartments, Industrial/Warehouse Properties, Office Buildings or any number of other types of properties.

When you finally decide on what you are going to buy, you need to be able to do the financial analysis to figure out if the property you are buying has positive investment potential. That means that it is priced right and it cash flows.

If you are interested in Multifamily Properties … otherwise known as Apartments… then one formula you may use to analyze properties is called the Gross Rent Multiplier Formula.

While some people feel that this is a simplistic formula that lacks the technical merit of a Cap Rate, IRR or any other investment formula that may take a more aggressive approach to due diligence, the Gross Rent Multiplier can be useful for quick and accurate calculations.

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First of all, the Gross Rent Multiplier is simply the ratio of the value of a property to its annual income before taxes, insurance, maintenance, utilities, etc.The before expenses nature of the formula is part of the flaw of the formula…as well as why it is so effective. One owner’s expenses on maintenance, utilities and management may not be the same as the next owner that has less maintenance to do or is an owner operator or has hundreds of units and managing a few more will not really raise fixed costs… Simply put, fixed and variable costs could vary between owners or over time - so not taking them into account allows for a potential owner to increase their own return.

A simplistic version of how this could work is - present owner markets vacancies on flyers with tear off numbers on bulletin boards at coffee shops within 1.5 miles of the property as opposed to the future owner who markets using a combination of craigslist.com and other websites read by thousands of renters daily. One method may be more effective than the other which will keep vacancy lower and help turn over vacant units faster.

Secondly, the Gross Rent Multiplier takes into account Income and Value… just like an appraiser. A commercial appraiser will use not only the Replacement Cost Approach and the Sales Comparison Approach to get the value of this property but also the Income Approach. The GRM already uses the two more technical methods of Income and Sales Comparison.

Huh?? I didn’t mention Sales Comparisons yet? Well… one way to get the GRM to value a property is to call your Appraiser or local Commercial Real Estate Agent and ask for Comps for the property you will be buying. Figure out the GRM for all those comps and average them and you’ll have a basis for your potential GRM on your new investment property. The more comps you use and the better the comps, the better your analysis will be!

Third, and here is part of the simplicity of the GRM, if you look closely at how the formula below really works, you will notice that the GRM is the number of years that it takes for the Annual Gross Rents to equal the Purchase Price or Acquisition Cost Basis (remember improvements and depreciation change the cost basis).

Now while that is not Breakeven because it does not account for Expenses… it can show how strong the revenue stream is in an investment properties. Cash Flows can then be addressed by close management of expenses and Rent Stabilization.

Fourth, and most importantly, some investors use the GRM backwards… because that is their internal formula. Just like an investor that only buys properties with a certain Cap Rate or a certain Internal Rate of Return (IRR), some investors know that they will only buy properties that have a certain GRM.

There are some “old school” investors that will look at a property’s rent roll… and not even bother with the expenses. They will eyeball the property to see if they can tell if there are any huge deferred maintenance expenses and then take their internal number… for instance 5. The Investor will then multiply their GRM of 5 by the annual rents and that will be what they are willing to pay for the property. If a property makes $100,000 in annual rents then they’re going to pay as close to $500,000 as possible.How can they be so precise? Experience. There is a vague rule of thumb or rumor that says that the monthly rent needs to be 1% of the purchase price. That number implies a GRM of 8.33 as some magical number. I have seen great investments that are higher and lower GRMs than 8.33, though… but it is that “rumor” started by a combination of experienced and analytical investors that has made the GRM still a valuable tool in analyzing a rental property.

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The formula for the Gross Rent Multiplier is

• • 1. Value = Annual Gross Rents x Gross Rent Multiplier …or

    2. Gross Rent Multiplier = Value / Annual Gross Rents …or

    3. Annual Gross Rents = Value / Gross Rent Multiplier

I expressed the formula in three ways to show you how many ways this formula can help analyze a property.

1. This version is how an appraiser or investor may arrive at a property’s value based on the analysis of the annual gross rents of a property multiplied by the GRM that is found using the Sales Comparison Approach (sales comps of similar properties in the area). As I said before, an experienced investor may have an internal number that makes his/her investments work and the GRM will come from experience regardless of sales comps.
2. This version shows you how to figure out what the GRM is when looking at a property’s listing sheet and rent roll. If you know the comps in the area or your internal GRM, then this will show you very quickly if a property is priced right for your investment.
3. This version of the formula would be used if you were analyzing a property prior to knowing what its rent roll says. You may or may know know what market rents are in the area but you know that when you see the rent roll what they should be.

Knowing how to analyze a property with GRM is often easier for an investor than IRR which requires some forecasting or Cap Rate which requires a calculator in most cases or Cash on Cash Analysis which requires knowing all a property’s financials.

So if you are looking to invest in a property, make sure to do your analysis completely so you know more fully the value of the investment to you.

To read more about Commercial Real Estate follow this link -o-> Commercial Real Estate and Mortgage Info

To read about another formula used in Commercial Mortgage / Finance follow this link -o-> Investment Formula - Debt Service Coverage Ratio

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David A. Podgursky, MBA
The Mortgage Go To Guy!
Your Source for Residential and Commercial Mortgage Loans in Florida

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