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The Gross Rent Multiplier (GRM) is a valuation approach used in the commercial real estate industry. It calculates the approximate value of income that a property produces based on its gross rental income. Simply put, it is an estimate of how much money your property will make and how long you need to wait until your property pays for itself.
Gross rental income includes income derived not just from rent, but also the money you earn from the property in other ways. Some examples are parking fees and vending machine profits. Gross rental income does not include property taxes, utilities, insurance, and other expenses.
To calculate GRM, simply divide the property’s annual gross rental income by its purchase price. So if the property costs $150,000 and its gross rental income for one year is $40,000, the equation will look like this:
$150,000 / $16,800 = 8.9 GRM
Like golf scores, the lower the GRM, the better. Your findings will come in handy when you’re comparing potential investment properties.
While a price-to-rent ratio is simple and easy to calculate, it does not take into account your operating expenses. For example, some markets have much higher property taxes than others. In situations like these, you’ll need to use more comprehensive calculations to get a closer estimate of how much money will go into your pocket.
Your Net Operating Income (NOI) is your total gross scheduled rent minus all your expenses—property taxes, insurance, HOA fees if any, property management fees, as well as "vacancy" and "maintenance" estimates.
To calculate NOI, use this equation:
Gross Scheduled Rent - Operating Expenses - Maintenance and Vacancy Estimates = NOI
We’ll use the same example we used in the previous section, a $150,000 property that earns $1,400 rent per month and includes some expenses.
A capitalization rate or cap rate is simply your annual net operating income divided by your purchase price. To get your property’s cap rate, perform the following equation:
Cap Rate = Annual NOI / Purchase Price
So, sticking with our example, you would multiply your $905 monthly NOI by 12 to get your annual NOI of $10,860.
$10,860 / $150,000 = Cap Rate 7.24%
Note: the higher the cap rate, the better.