Learn How to Quickly Determine the Value of a Commercial Property Using the Gross Rent Multiplier (GRM) Valuation Approach
If you are applying for a commercial mortgage then you are well aware that commercial appraisals are expensive, often exceeding $3,500. Fortunately, there are a few basic ratios that you can use to help get an indication of value of income producing commercial real estate before approaching your commercial lender. The gross rent multiplier (GRM) is one of those methods.
What is the Gross Rent Multiplier (GRM)
The Gross Rent Multiplier (GRM) is a capitalization method used for calculating the approximate value of an income producing commercial property based on the property's gross rental income.
While it sounds a little tricky, it really is quite easy as long as you have access to some basic information.
How to calculate the value of a property using the Gross Rent Multiplier (GRM)
To calculate the value of a commercial property using the Gross Rent Multiplier approach to valuation, simply multiply the Gross Rent Multiplier (GRM) by the gross rents of the property.
How to calculate the Gross Rent Multiplier
To calculate the Gross Rent Multiplier, divide the selling price or value of a property by the subject's property's gross rents. To get an indication of the GRM for a specific property type and location it's a good idea to contact a local commercial appraiser, a local commercial real estate agent, or calculate a GRM on your own using recent comparable sales - more on this later. With the abundance of information available online, it should be fairly easy to determine a GRM from online commercial real estate listing sites, research providers or commercial real estate brokers.
The GRM calculation of value
Property Value = Annual Gross Rents X Gross Rent Multiplier (GRM)
$640,000 = $80,000 X 8 (GRM)
In this example - using a GRM of 8 - a property that generates $80,000 a year in gross rental income has a value of $640,000.
Pretty basic, so how accurate can the Gross Rent Multiplier (GRM) valuation method be based on such as simple approach? While using the GRM to value a commercial property has it's limitations, its actually quite accurate and makes sense once you understand the basics of a commercial appraisal.
A commercial appraisal typically values a property based on a three tier approach: income, replacement, and sales comparison. In the simplest of terms, the conclusion of value of a commercial property blends the income and sales comparison methods together (NOI divided by CAP rate) to determine the property's actual value.
What is a Cap Rate?
What is a cap rate - A cap rate is what investors expect to earn as a percentage of their investment on an annual basis.
Commercial real estate valuation is a very complex business with many variables that affect price. Over the years investors found that they needed a way to compare property values, essentially price, in a market using a shorthand method, thus capitalization rates or cap rates came into general use. In simple terms, a cap rate is what investors expect to earn as a percentage of their investment on an annual basis. For example, a property with a cap rate of 10 tells a buyer that he should expect a 10% return on his investment assuming a debt free transaction.
How to calculate a cap rate - Formally, Direct Capitalization (cap rate) is a method used to convert a property's annual net income (NOI), into an estimate of the property's value.
Value = Net Operating Income / Capitalization Rate
Cap Rate = Net Operating Income / Value
In general, the lower the cap rate, the higher the property's value, and the higher the cap rate, the lower the value. In other words, a property with a lower cap rate compared to a property with a higher cap rate will return less income to the investor.
Markets like San Francisco, Manhattan, Seattle and Miami tend to have some of the lowest cap rates in the country. Properties located in secondary and tertiary markets tend to have higher cap rates rewarding the investor for taking additional risk by purchasing in a smaller market.
The major difference in valuation between the income approach to valuation via the appraisal and the GRM approach to valuation is the former uses net income in the calculation of valuation while the latter uses gross income.
How to calculate your own Gross Rent Multiplier
Contact a commercial real estate agent or go online to a commercial listing site or the commercial section of any major real estate brokerage firm and get several listings of property types similar to yours.
Calculate a GRM
To calculate a GRM, take the listed selling price and the annual gross rental income and divide one into the other, the equation looks like this:
GRM = Sales Price / Annual Gross Rents
8 = $640,000 / $80,000
In this example, the GRM for a property with a listing price of $640,000 and $80,000 in gross rental income, is 8. Next, simply average the respective gross rent multipliers together and you will have a good indication of the local market GRM for your property type.