 ## How to use Gross Rent Multiplier in Commercial Real Estate Financial Models

###### Written by: Lucro Staff 3 years, 9 months ago

In commercial real estate valuation, there are a number of methods one can employ to get to a market value for a particular asset. Some of these techniques are more accurate and involved while others are more useful for a quick gut check. Utilizing a Gross Rent Multiplier (GRM) is one way to get at a quick “back of the envelope” value for a commercial real estate asset.

While simple and easy to use, GRM does come with its own set of limitations and misconceptions.

Below you’ll find a breakdown of the definition of Gross Rent Multiplier and how you can use it in your commercial real estate financial modeling.

What is a Gross Rent Multiplier?

The Gross Rent Multiplier is a very simple formula used to calculate the value of income-producing commercial real estate based on the property’s Gross Potential Income. At its core, GRM is a number that displays the ratio of the Price of an Asset to the Gross Potential Income (annualized) of that asset. The formula used to calculate the Gross Rent Multiplier is below:

Gross Rent Multiplier (GRM) = Price / Gross Potential Income

By multiplying both sides of the equation by Gross Potential Income, we can solve for Price, as per the below:

Price = Gross Rent Multiplier (GRM) x Gross Potential Income

The particular GRM you would use in the above equation is largely dependent on the market rate for your individual market or submarket. In other words, it would be the GRM of similar properties that are in the same market as the asset you’re evaluating. It’s important to remember that there is no set “goal” for the optimal GRM, but the numbers should always be compared relative to a peer group.

While the Gross Rent Multiplier is a simple and effective tool, it does come with its faults. You can think of using GRM in real estate as being analogous to using revenue to measure the value of a business. In reality, as with any asset, your return is not based on the gross potential income—it’s based on the cash flow. This means that GRM does not take into account some important factors, like your property’s operating expenses, mortgage amortization, change of the future value, and financial leverage. Therefore, GRM is best used to arrive at a rough estimate of property value, which should always be backed up by a more thorough discounted cash flow methodology.

How it Works

Now that you understand what the Gross Rent Multiplier is and how you should be using it, let’s run through an example with real numbers. By using the standard formula we mentioned above, you can simply plug in the relevant numbers as they relate to your specific investment property.

For example, let’s say that we’re evaluating a retail property in a market where the retail GRM tends to be around 8.3. Furthermore, let’s assume that the target property has an annual gross potential income of \$60,000. By plugging these two figures into the formula below, we can easily estimate the property’s sales price.

Price = Gross Rent Multiplier (GRM) x Gross Potential Income

Price = 8.3 * \$60,000

Price = \$498,000

Once we’ve calculated the figures, we can see that the price of this particular property is likely to be in the neighborhood of \$498,000.

It’s important to reiterate that a commercial valuation will generally value a property using a three tier approach, as opposed to just one methodology. These three tiers are discounted cash flow, replacement cost, and sales comparables. While the Gross Rent Multiplier does come with its caveats, GRM is a simple and widely used method for measuring the value of commercial real estate.