The "Rubber Chicken" Of Commercial Property Value Indicators By Monte Lee-Wen At Isnare.com Ezine Articles

The Gross Rent Multiplier - the Rubber Chicken of Commercial Property Value Indicators.

Now a Rubber Chicken is pretty useless ... except as a practical Joke. Let's take a look at the most useless number in Commercial Real Estate.

The Gross Red Multiplier (GRM) is a number you will see on every Broker's pro forma. And it is touted as a measurement of the "Property's Value". If anyone out there really sets a property's value based on GRM ... I have to wonder what they are smokin'. I'm not really sure what a Gross Rent Multiplier measures, but it certainly is NOT the Value of the Property.

GRM is calculated by dividing the Property's sales price or value by the Gross Potential Income.

Example:

A $1M property with a $100K annual Gross Potential Income. This property has a GRM of 10.

Price (Value) / Gross Potential Income = GRM
$1M / $100K = 10

The GRM number can be thought of as similar to a Price Earnings Ratio for a stock. The Gross Rent Multiplier is the amount of time it would take you to pay for the property if you were actually collecting the Gross Potential Income and putting it towards the property purchase. For our example property: If you were able to collect that hundred thousand dollars a year and you magically devoted all of it to paying for the property ... it would take 10 years for you to complete your purchase.

Beware of the Gross Rent Multiplier.

It can help you compare price between different properties, however, it is absolutely and totally useless as an estimate of value to a returns focused investor. You are focused on the Return on your Investment. You are focused on the Bottom Line. And the GRM is about as much help in understanding your ROI as a Rubber Chicken.

Since the Gross Rent Multiplier only deals with Gross Potential Income, it is flawed for two main reasons.

1) We're talking only about "Potential Income" based on the Broker's most optimistic projections of attainable rents. The basic number has no basis in reality - especially if you are looking for a property with upside. Think about it for a second ... if the Seller could get these rents for this property they wouldn't be selling!

2) Gross income starts at the top of the financial statement. For any particular property there is absolutely no relationship between the Gross Income, and the Net Operating Income (NOI) down on the bottom line. You have to know the Real Income and the Real Expenses to understand the actual NOI this property can produce.

It is only when you understand the Net Operating Income that you can calculate your potential Return on Investment.

Our advice...

Whenever you see the term Gross Rent Multiplier ... just ignore it.

And if a promising property shows up ...ask for the rent rolls and the financials and figure out the Net Operating Income as best you can. With the bottom line Net Operating Income and potential price in hand, you will be able to calculate your Return on Investment.

With this solid, fact based set of numbers you can make an offer based in reality. Doesn't mean the Seller will accept it... and at least you start the negotiations with your feet on the ground.

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