# Understanding the Gross Rent Multiplier in Commercial Real Estate

Understanding the gross rent multiplier is important when evaluating commercial real estate transactions. The gross rent multiplier is a simple measure of investment performance that’s popular in the commercial real estate industry, but it also comes with several built-in limitations. In this article we’ll explain the gross rent multiplier in detail, show you how to use it, and also discuss some limitations and common misconceptions.

## Gross Rent Multiplier Formula

First of all, what is the gross rent multiplier? The gross rent multiplier (GRM) is a simple measure of investment performance used to compare alternative investments. The gross rent multiplier formula is calculated as follows:

As shown in the formula above, the gross rent multiplier is calculated by taking the price of the property and dividing it by the potential gross income of the property. Also, notice that if we rearrange the above formula we can solve for the price of the property:

The gross rent multiplier can be used to quickly survey the market for opportunities by filtering out properties with a low price relative to the market based gross potential income. The gross rent multiplier can also be used to value a property by using the gross rent multipliers (GRMs) of very similar properties within the same market area.

## Gross Rent Multiplier Example

Let’s take a quick example to illustrate how the gross rent multiplier works. Consider a commercial office building with a year 1 gross potential income of \$100,000 and a price of \$1,000,000.

The gross rent multiplier in this case is simply \$1,000,000/\$100,000, which results in a GRM of 10x. So what does this gross rent multiplier of 10x mean? By itself, not much. But when you compare this GRM with other very similar properties, it can give you a quick indication of whether it’s in line with those other similar properties or not. This could be helpful when quickly evaluating several potential acquisitions in the same area. If one of the properties has a smaller GRM than the others, it may indicate an opportunity.

Let’s take another example of the gross rent multiplier where you want to use the GRM to estimate the value of a property. Let’s say that you’re thinking about listing your investment office building for sale, which has gross potential income of \$50,000 per year, and you want to get a rough indication of value. After surveying the market for recently sold comparable buildings in the same area, you determine that the average gross rent multiplier is 11x. Based on the GRM formula above, you can use this information to get a rough value estimate for your building of \$550,000.

## What is a Good Gross Rent Multiplier?

The gross rent multiplier is best used when compared to other gross rent multipliers for similar properties located in the same trade area. What this means is that GRMs will be different for different groups of properties in different locations.

As such, there is no one magical gross rent multiplier figure that can be used as a rule of thumb. Instead, the GRM should be compared to a peer group.

## Limitations of the Gross Rent Multiplier

Using the gross rent multiplier is essentially like using revenue for a corporation as a measure of value. The problem with this approach is that when you purchase an investment property, your return isn’t based on top line revenue (gross potential income), but rather it’s based on cash flow.

In other words, without taking into account a property’s operating expenses, appreciation or depreciation of future value, financial leverage or mortgage amortization – it’s simply not possible to estimate your true return on investment.

Consider the following proforma for a small office building:

In the first proforma above, the potential gross income in year 1 is \$168,750. Based on an acquisition price of \$1,000,000, the resulting gross rent multiplier in year 1 is 5.93x. By itself this doesn’t tell you all that much, but suppose you’ve been underwriting several other office buildings for sale in the same area and you have determined that the average gross rent multiplier for these similar properties is 5.00x.

In this case, the gross rent multiplier for the above property seems high when compared to other similar properties. If you were using the gross rent multiplier alone as your criteria for evaluation, you’d probably discard this property and move on. But is that the right decision?

As mentioned earlier, the gross rent multiplier doesn’t take into account vacancy, expenses, disposition prices, or any of the other factors that affect the bottom line cash flow of a property. Without digging into all of these details it’s not possible to know what your true return will be on this property as an investment.

To illustrate this, let’s take a closer look at the above property using a discounted cash flow analysis.

The above discounted cash flow analysis takes into account the cash flow before tax for each year in the holding period, which of course includes vacancy, expenses, and all of the other items the gross rent multiplier ignores.

Based on an acquisition price of \$1,000,000 and a discount rate of 10%, the resulting unlevered net present value is \$45,112, and theĀ internal rate of return is 11.15%. If we’re able to secure a loan at a 70% loan to value (\$700,000) at 5% amortized over 20 years, then our internal rate of return will improve to 22.48%.

Now is this a good investment? Of course that depends and there are many others factors that have to be taken into account. But, assuming your discount rate is 10%, this would certainly be something to take a closer look at. And, as shown above, it would completely fly under the radar of the gross rent multiplier.

## Closing Thoughts on the Gross Rent Multiplier

The gross rent multiplier is a simple measure of investment performance that has several advantages. It requires very little information to calculate, the required information can be easily obtained, comparable properties within the same market area should have roughly the same gross rent multipliers, and overall the GRM concept is fairly easy to understand.

Of course, as we detailed above, the gross rent multiplier has several built-in limitations that you should be aware of. Ultimately, the solution to these gross rent multiplier problems is to build a complete proforma for your property and then run a full discounted cash flow analysis. To quickly build a real estate proforma, and run a discounted cash flow analysis plus other financial metrics (like the GRM), you might consider our real estate investment software.

• Fitz

Thanks very much for the well presented presentation. Very helpful illustration

• Peter Morris

I’m glad you touched on they point as I’ve heard GRM used by unsophisticated investors. You aptly note that the top line revenue doesn’t correlate to the actual return to the investor. And GRM is completely useless in NET Rent buildings. Always better to use the discounted cash flow of the NOI.

• Victor Kaminski

GRM is used as a comparison, it is not a percentage like CAP rates, it is only a multiplier, the number itself means nothing but if you have a property with 5 rental units and you know all the income and expenses to calculate the cap for it and have other similar properties you’d like to explore. You can determine the GRM for the property you have all the info for then apply that GRM to the similar properties without all that info available to use as a quick rough and dirty comparing tool which should get you in the same ball park. It’s not exact but can be a useful tool if you are looking for properties and don’t want to go through all the privacy agreements, etc to find out the properties income/expenses etc when you only want to see it.

• Trevor Ruth

Tcrutherford22@gmail

• Victor Kaminski

Not sure what Peter was referring to talking about NET rent buildings.
Did he mean percentage leases which are based in part on the income of
the business in addition to a lower base rent or a Triple NET lease
which GRM will work even better for since expenses won’t matter as much.

I
am a real estate licensing instructor in New Jersey and usually explain
GRM like this, although most agents I know don’t use it. It can really
be a great time and effort saver. It’s not a percentage or a rate it is a multiplier.

It is a rough and dirty way to
tell if a property may be a good investment based on other properties
you may have more complete information about, therefore can soft through many properties much quicker.

For a property you
already calculated a CAP rate for and think is a decent investment and
you have a client looking for investments in the same range of return,
calculate the GRM for the same property then use that as a baseline for
comparison to others which you may not know the income, expenses for but
can guesstimate the rentals based on others in the area to calculate comparables GRM and it should get you in the same ball park.

I
think it’s by no means an accurate tool but once you find properties in
same GRM range as your baseline property, you could then seek out the
true income/expenses to determine the CAP rates and see if it is
something you now want to make an offer on.

• Real Estate Guy

There is an awesome real estate app I used 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.