It’s time to cover another commercial real estate metric, this time the gross rent multiplier (GRM).
We’ve already covered the following commercial property metrics, all of which are designed to provide insight into potential commercial real estate property investments:
These could all be classified as ‘napkin checks’ and are designed to provide quick evaluations of commercial property investments for comparative purposes.
The gross rent multiplier is one of the simplest commercial real estate metrics around, and thus, it comes with more than its fair share of limitations.
The gross rent multiplier formula is very simple. It takes the cost value of the building and divides it by its potential gross income (e.g. rental income).
So, for a building worth £1,000,000 that has a rental income of £100,000 per year, the gross rent multiplier is 1,000,000/100,000 = 10x.
Compare this to say, a building that costs £2,200,000 and a rental income of £200,000 per year. In this case, 2,200,000/200,000 = 11x.
The lower the gross rent multiplier, the quicker the return from rent is. If you collect rent from the first example here for 10 years, you’d have recuperated the initial cost of the building. In the second example, you’ll need 11 years.
So, what does the gross rent multiplier mean on its own? Very little, because, as many will have already sussed out, these figures don’t include the property’s operating expenses, any additional fees that increase the initial cost figures, the appreciation or depreciation of future value, mortgage amortization or financial leverage.
The gross rent multiplier figure does have its uses. If, for example, a set of office units is part of a much larger block, and an investor is looking to compare various units within that same block (which, for argument’s sake, all have similar operating expenses and other associated costs), the GRM provides a means to quickly compare the profitability of similar options.
Two office neighbouring office blocks might have near-identical characteristics, but if one has a slight edge on the other, thus making charging slightly higher rent possible, it will exhibit a lower GRM. Lower GRMs are better – they indicate a quicker return on your initial purchase.
GRM can also be used in reverse. The price of a building = potential gross income x GRM. So, you could survey local markets to discover that the average GRM in the market is 10x. If your building yield a gross rental income of £50,000, then a rough price for the building would be within the £500,000 region based on a 10x GRM.
As we can see, GRM is quick and effective to a point. So what are the limitations of the gross rent multiplier?
Firstly, we need to consider what gross income actually is. For most buildings, this is income collected via rental payments. However, there may be other income, e.g. from machinery hire, managed services or even vending machines.
GRM can be likened to revenue as a measure of corporate value. In reality, investment is about cash flow rather than top-line revenue. Whilst a building’s GRM might look favourable to another similar building in its class, it provides no insight whatsoever into other costs. In other words, GRM does not use the net operating income of a building unlike the capitalisation rate, which does indeed use net operating income rather than gross income.
Commercial real estate investment revolves around much more than just gross rental income, investors need to induct information about the property’s operating expenses, vacancy rates, additional purchase fees and mortgage or finance interest rates, the appreciation or depreciation of the property’s future value and financial leverage.
But, this information is not always to hand, just like mortgage payments aren’t included in the capitalisation rate calculation, not because this isn’t useful, but because mortgage information is not always known or to-hand when casting the net wide and conducting initial research on commercial property investment opportunities.
Like any other single metric, GRM cannot be taken as gospel. For example, say a building displays a GRM of around 6x, which seems high for its area average which is more like 5x. Using the GRM alone, one might discard this building or erase it from the shortlist.
However, say this particular property has a lower vacancy rate than others in its area. Immediately, that higher GRM is no longer representative of the building’s viability. In essence, GRM is only useful when nearly every single comparative characteristic of each investment opportunity are identical.
The capitalisation rate would however take these vacancy rates into account, but what if you don’t know, or don’t need to know because you know the area well already and are looking for quick and dirty metrics that back/contradict your own insights and thoughts? That’s where the GRM excels – it’s a quick and dirty metric suitable for quick comparison of similar-class buildings with similar characteristics, similar operating expenses and similar expected net operating incomes.
The more metrics you can use to assess a commercial property investment, the better.
Focussing on just one or two metrics or measures will lead to conjecture, abstraction and assumptions. Of course, the more information you possess about the following, the better your assessments of the investment will be:
- Finance; mortgages, loans, interest rates, etc
- Acquisition fees
- Property management fees
- Tenants; rent or lease terms
In many cases, comparing the building to other similar commercial properties nearby is a good place to start. Stats from similar commercial investments in the same area can provide a fairly comprehensive overview of what rents or leases might look like.
This is where the GRM comes into play – it’s good for comparing neighbouring commercial buildings, or those distributed in similar socioeconomic and socioenvironmental regions.
The Gross Rent Multiplier (GRM) is a simple commercial property metric that takes the price, value, or cost of a building, and divides it by the potential gross rental income.
Buildings that exhibit lower GRMs exhibit quicker returns, at least in theory.
GRM can be compared to business revenue – it’s a metric that fails to take profit into account as it doesn’t deduct any costs except the initial outlay of the building.
It’s best used to compare immediately comparable commercial investment opportunities, e.g. within the same area, or maybe even the same block or commercial premises or business park.