I’m often asked which of these methods is better or more accurate and I discovered this article for our readers.

GRM vs. CAP Rate
by Michael Setunsky

Which method is more viable as a way to value a real estate investment, the Gross Rent Multiplier (GRM) or the Capitalization (CAP) Rate? Let’s look at these two methods one at a time and then compare the two.

Gross Rent Multiplier

The GRM also called the Gross Income Multiplier is a very rough “Rule of Thumb” approach to valuing an investment. Webster’s New Collegiate Dictionary defines a rule of thumb as a general principle regarded as roughly correct but not intended to be scientifically accurate. In other words the GRM is a ballpark estimation tool for assessing the market value of an income producing property.

Calculating the GRM:

Market Value / Annual Gross Income = GRM

Comparable Sales

Comparable No.            Market Value               Annual Gross Income              GRM
1.                                   $800,000.00                 $150,000.00                             5.33
2.                                   $775,000.00                 $145,000.00                             5.34
3.                                   $850,000.00                 $160,000.00                             5.31

Median GRM: 5.33

Calculating the estimated Market Value:

GRM x Annual Gross Income = Market Value

Subject Property:

GRM Annual                    Gross Income                  Market Value
5.33                                   $150,000.00                   $799,500.00

CAP Rate

The CAP Rate or Capitalization Rate is the rate of return on an income producing property for the first year. Calculating the market value is more detailed using the CAP Rate.

Calculating the CAP Rate:

Net Operating Income (NOI) / Market Value = CAP Rate

Comparable Sales

Comparable No.           Market Value                    NOI                          CAP RATE
1.                                  $800,000.00                     $60,000.00               7.50
2.                                  $775,000.00                     $56,000.00               7.23
3.                                  $850,000.00                     $65,000.00               7.65

Median CAP Rate: 7.50

Calculating the Market Value:

Assumptions: Vacancy Rate = 10%
Operating Expenses = 38.62%†

NOI / CAP Rate = Market Value

Subject Property:

CAP Rate                             NOI                                     Market Value
7.50                                      $75,070.00                         $1,000,933.00

GRM-vs-CAP-Rate GRM vs. CAP Rate

There is more than a $200,000.00 difference between the market value using the GRM and the CAP Rate methods. Notice that GRM does not take into account the Vacancy Rate or the Operating Expenses. These two items can significantly change the market value, as demonstrated above.

In summary, the GRM may be useful for providing a rough estimate of value when initially comparing properties to determine if a more in depth analysis is required. Once you have narrowed down the potential properties, the CAP Rate method should be used for a more accurate analysis.

A final thought. No matter which method is used, the outcome is only as good as the information initially obtained. Strive for initially acquiring accurate and reliable property data prior to completing your analysis.

†Operating Expenses derived from median ratio of NOI to Annual Gross Income for comparables.

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Filed under: Investor Words, Real Estate Market, VRN