Real Deal REInvestor Network

Personal GRM
Your GRM number comes from your unique investment desires, which comes with practice. You arrive at it by analyzing each and every property of interest that comes along. After a while, you’ll notice that the only ones that interest you are the ones with perhaps a GRM of 6 or less.
You settle on this personal number after analyzing multiple properties in the marketplace. You won’t have to do this more than 20 times before you begin to see the relationship between property, income, and price immediately.
Tip: Other investors in the marketplace may not agree with your assessment and try to get you to use their GRM. Remember, you may be taking deals that someone else wouldn’t touch—only time will tell which one of you were right. You will probably have a different GRM for different properties.
When getting started in the business, consult with a trusted commercial realtor for their estimate of GRM for each distinct market.
GRM Class Differentiation
In the stock market, the PE ratio is different between classes of stock, like between gross stocks and fixed income stocks, or software stocks and utility stocks. In the same manner, the GRM will be different depending on property class (A, B, or C).

Rules of Thumb
Most investors use three financial strategies or rules of thumb to analyze the feasibility of a deal. These rules provide a method of sorting through the deals that you find in your market, so that you can select the most profitable ones.
One filtering device was presented earlier in this module. In the My Mother-in-Law the Investor chronicle, the first of those three questions was, “What do you want for it?” This query was used as a filtering device or rule of thumb. Another rule of thumb you will be reviewing next, Gross Rent Multiplier (GRM), was touched on in an earlier module. The final rule to be discussed here is known by many names:

Direct Capitalization, “Cap Rate”, or IRV Formula.
Gross Rent Multiplier (GRM)

GRM is based on the first year’s Potential Rental Income (PRI), which is everything you might be able to get from a particular property, if 100% of the units were rented at market rent. The GRM takes advantage of the simplicity of the PRI number since it’s the easiest number to find in the marketplace.  You simply multiply the PRI by your GRM to get an estimated value of the property.
For example, if you’re considering buying a 20,000 square foot warehouse with a market rent of $5.00 per square foot, the PRI is $100,000.
The GRM, like any rule of thumb, is unique to you.  It is based on your desired investment criteria. You never use someone else’s number. If your GRM on the above example were 5, then the most you would want to pay for the property would be $500,000. If you look backwards at the sales that have taken place, it may seem that most people are buying at a GRM of 6. However, you decided that nothing worthwhile could be purchased above 5, so 5 is your number.
Key Point
The bigger the GRM, the greater the price. If you’re calculating price from a gross of $100,000, the price should be no more than five times the income for a GRM of 5. That means the price should be no more than $500,000.
On the other hand, if your GRM was 8 and the property is priced it at less than $800,000, you should definitely consider purchasing it.
GRM is like the price to earnings ratio (PE) on a stock, but that’s the kind of a rule of thumb it is.  Like the GRM, your PE is different for different kinds of stock, in different times of the year and different times of the market.
You could say that certain software stocks have a PE of 30. In the real estate market, you might say something like, “Downtown Class “B” office buildings better hit a GRM of 7 or less or I’m not interested in looking at them.”
Thus, a GRM of 7 times $20 a square foot (about average for Orlando Class B rent), equates to $140 a square foot. That’s about as high as you want to go for an office building. So your rule of thumb for office buildings is consistently 7. If someone has a property priced at $200 per square foot, unless his income is $30 per square foot (and it won’t be—not in this market), you wouldn’t think he was serious about selling.

Instead of creating my own definition for what is a Gross Rent Multiplier, I have pasted a very clear definition from Invest to Win software company.

So... what is a Gross Rent Multiplier?

"The Gross Rent Multiplier or GRM is a ratio that is used to estimate the value of income producing properties.  The GRM provides a rough estimate of value.  Only two pieces of financial information are required to calculate the Gross Rent Multiplier for a property, the sales price and the total gross rents possible.  If this information is available for multiple recent sales of similar types of income properties in a particular area, it can then be used to estimate the market value of other similar properties in that area.  Some investors use a monthly Gross Rent Multiplier and some use a Yearly GRM.  The monthly Gross Rent Multiplier is equal to the Sales Price of a property divided by the potential monthly rental income and the Yearly GRM is the Sales Price divided by the yearly potential rental income.

Example 1:  If the sales price for a property is $200,000 and the monthly potential rental income for a property is $2,500, the GRM is equal to 80. Monthly potential rental income is equal to the full occupancy monthly rental amount which assumes all available rental units are occupied.  Generally speaking, properties in prime locations have higher GRMs than properties in less desirable locations.  When comparing similar properties in the same area or location, the lower the GRM, the more profitable the property.  This statement assumes that operating expenses are proportionate for the properties being compared.  Since the GRM calculation doesn't include operating expenses, this statement might not hold true for similar properties where one of the properties has significantly higher operating expenses.

                                                                 Sales Price                                    $200,000

GRM (monthly)  = -------------------------------  =    --------------- =   80

                                               Monthly Potential Gross Income            $2,500

 

Example 2:  We have several similar properties that have sold recently in the same area and their average monthly GRM is 80.  We can use this information to estimate the value of comparable properties for sale.  If our monthly potential gross income for a property is equal to $3,000, we would estimate its value in the following way. 

Estimated Market Value  =   GRM     X     Potential Gross Income

                     =     80    X     $3,000    =    $240,000

A market GRM can provide a rough estimate of value, but it does have some limitations.  The GRM calculation doesn't include a property's operating expenses and vacancy factor.  We could have a situation where two properties have approximately the same potential rental income, but one property has significantly higher operating expenses.  The above formula would result  in a questionable estimation of the market value for these properties.  Also, the above GRM formula uses the monthly potential rental income and doesn't account for a vacancy factor which could have an impact on the accuracy of the property value estimates.  The seasoned investor understands the above limitations and uses the gross rent multiplier to get a quick feel for the potential market value of an income property.

The GRM is sometimes calculated using the effective gross income rather then the potential rental income thus incorporating the vacancy factor in the GRM calculation.  Effective Gross income equals potential rental income minus the vacancy amount. When vacancy rates are a factor, using the effective gross income will produce a more reliable estimate.

The capitalization rate is a more reliable tool for estimating the value of  income producing properties since vacancy amount and operating expenses are included in the cap rate calculation.  The GRM is useful in providing a rough estimate of value..."

Note: Remember that this is not the way you would determine the intrinsic value of a property, this is a quick way to get a ball park figure. The GRM will help you to walk away from projects that are clearly out of the figures you have established in your local investing area (saving you time). If the numbers look good... then you can take further steps to determine the value of the property and to negotiate your purchase.

Rick Melero

www.RealDealCommunity.com

www.HisRealEstateNetwork.com/commercial