What is Gross Rent Multiplier (GRM)?
In a recent blog post, I explained the use of Cap Rate by investors as a financial technique to estimate value when considering the buying or selling of a multi-family apartment building. Another metric used in real estate is Gross Rent Multiplier (GRM). Like Cap Rate, GRM is simply a gauge of value, but it can be used to quickly compare investment opportunities. GRM accounts for the gross rents as measured against the selling price. It’s calculated by taking the price and dividing it by the total annual gross rent. For example, a price of $1 million divided by $100,000 in gross rent produces a GRM of 10. Generally, GRM’s in the Northern Virginia region vary widely between 6 and 16 based upon building location, rent level, age, and class. Generally, the higher the GRM the better the building and lower the perceived risk. Likewise, the higher the GRM the longer it will take an investor to recover their investment, meaning a lower ROI.
GRM can be useful when quickly comparing investments, but it has a few inherent flaws. First, it calculates the gross rent with no adjustment for vacancy. No building goes 100% occupied at all times. Second, it does not at all take into consideration operating expenses and buildings can have very different expense profiles depending on management and building systems. Like Cap Rate, GRM is only a starting point in determining value. The only way to accurately determine enterprise valuation is by financially modeling the complete rent roll with vacancy, accounting for all expenses and loan costs, and calculating ROI & IRR like described in the next section.
Return on Investment (ROI) & Internal Rate of Return (IRR)
ROI and IRR are absolutely necessary when analyzing the buying or selling of an apartment building. Both methods require preparing a pro forma income statement like the table below. When in search of the most accurate investment performance, one must analyze all income against all expenses. This is the only way to evaluate the financial holy grail of any business – cash flow. Cash flow, and the resulting ROI and IRR calculations, are the tools of sophisticated investors, certified financial analysts, and lenders alike.
ROI Just Begins to Draw Back the Curtain
ROI is a popular metric because of its versatility and simplicity. It’s important, because it requires preparing at least a Year 1 pro forma to estimate cash flow. This means consideration of the complete rent roll and vacancy, as well as accounting for all expenses, loan costs and even a maintenance reserve. The resulting free cash flow divided by the investment amount yields the investment profitability (ROI). However, ROI is very limited in that it only considers Year 1.
IRR Pulls Back the Financial Curtain Completely
Calculating the IRR should be the end game of any buyer or seller of an apartment building as it accounts for total return and long-term investment performance. As such, it requires preparing a multiple year income statement pro forma to forecast future rents and expenses. It requires contemplation of changes in loan costs, interest rates and when debt must be re-financed. It requires estimating capital improvements against the reserve fund, and even the net proceeds from a possible sale. The IRR is used to compare and contrast against the investor’s hurdle rate. The hurdle rate is the minimum rate of return required by an investor to proceed with a project. The IRR must exceed, or jump over, the investor’s minimum rate of return. Calculating the IRR is the only way to accurately measure investment performance, because it marries long-term projections with the long-term horizon under which a business actually operates.
⇒ Cap Rate = NOI / Purchase Price = $68,000/$950,000 = 7%
⇒ Building Value = NOI/Cap Rate = $68,000/0.07 = $950,000
⇒ GRM = Purchase Price/Total Gross Annual Rent = $950,000/$100,000 = 9.5
⇒ ROI = Investment/Cash Flow = $20,500/$190,000 = 11%
⇒ IRR = Time value of Investment + Cash Flow + Sale Proceeds = 24%
*IRR is the discount rate that makes the net present value of all cash flows equal to zero. It’s calculated in a spreadsheet using a specific formula too detailed to fully describe here.
“It is with much enthusiasm that we share with you our thoughts about Tim Trainum. He his the most knowledgeable and informed real estate agent with whom we have ever dealt. Over the last 45 years we have bought and sold a combination of 26 homes, condos, and multi-family apartment buildings in Fairfax, Arlington and other parts of the country. Tim is without a doubt the complete package. He did everything we asked him to do. He gave us great information and advice and kept us informed as to his progress day by day. We highly recommend him.” – Dean and Mary Simonds
I am a high-value agent who delivers demonstrably useful results to my clients. I operate my business with relationship-focused interaction that aligns client goals with beneficial outcomes. I have an unyielding commitment to being an open and honest advocate, ensuring my clients reach their desired outcome efficiently and with the most equity. My overarching passion in real estate is to join your buying and selling journey and help improve your quality of life.
I am a full-time, licensed Realtor® who has established deep roots and knows the region. I was born and raised in the Northern Virginia area, graduating from Chantilly High School and then James Madison University with degrees in Economics and Finance. I live in Fairfax with my wife Liz and our seven year old son Robby. I’m a homeowner myself and understand the important decisions my clients face when they’re buying or selling a home. In addition, I’m an owner of investment property, including a multi-family apartment buildings. I have a penchant for helping people having taught adult education courses in investing and personal finance, and helped numerous clients, friends and colleagues in creating a path to wealth creation. I also serve as the trustee for a private charitable memorial fund.
I have been working in the real estate industry helping clients for over 25 years. As a Listing Agent, the value I create for my sellers is to help them elevate and showcase home condition. I use multiple valuation techniques to pinpoint market value for my sellers. I use cutting-edge marketing strategies to promote widespread buyer awareness and produce the maximum selling price in the fewest days possible, while protecting my seller’s best interests throughout the complete selling and settlement process. As a Buyer’s Agent, I help my buyers locate the home that changes their life. I guide my buyers in structuring the most compelling offer that can win seller acceptance, while retaining the most value and equity possible for buyer benefit and in a manner that protects their best interests throughout the complete buying and settlement process. I have worked with clients in the purchase of investment property, helping them to prospect property as well as evaluate all the financial metrics important to making the investment. My real estate experience includes working in the development, construction and operation of real estate infrastructure projects, closing over $500 million, as well as supporting several commercial real estate clients in the pursuit of reaching their objectives. My experience spans across consulting with clients on remodeling and home improvement projects to negotiating land purchase agreements and easements, to negotiating residential and commercial leases. There are few areas of real estate that I haven’t touched and it continually has been with a mind-set of delivering exceptional outcomes.