Recently, I wrote an article about our experience in buying our first four properties. In the next couple of articles, Rob and I will be writing about three methods of comparing potential real estate investments and applying them to the TwoWiseAcres empire, such as it is. In this first article, I’ll be tackling Gross Rent Multiplier (when the mood strikes, I’ll be short-handing it as “GRM”).
But First, A Word about the North
While preparing this article, I ran across this interesting article at Quest for Four Pillars talking about GRM and Capitalization Rates for a couple of properties in Toronto. Besides being a good post on these measures in the real estate investing arena, it reminded me that TWA has the occasional reader in exotic places, such as Canada or even Silicon Valley, as well as the U.S. Considering that, I thought I would start with a few preliminary notes that we hope will assist our readers. First, whenever discussing percentages, we will be using the U.S. standard for determining percentages (i.e. 1/100 = 1%). I don’t know the Canadian equivalent, but I’m pretty sure you’d need a different calculator. Second, any reference to dollars will be in U.S. dollars. Again, I’ll have to plead ignorance as to the Canadian measurement of currency (Rob thought doubloons, but I’m fairly sure that’s Spanish) or its current relative worth. Third, and perhaps most important, if you are a U.S. resident considering real estate investments in Canada, or vice versa, be forewarned. Any resulting cashflow is unlikely to work in your home country’s soda machines.
Use Gross Rent Multiplier, But Rely on it Little
In the search for real estate investments, this is the easiest way to get a quick reference point to assess the income potential for a property. GRM is calculated simply by dividing the purchase price by expected rents. For example, assume you’re looking at a property with a price of $100,000 and estimated annual rents of $10,000. GRM is $100,000 ÷ $10,000 = 10. Because we want to pay the lowest price possible for the highest rents, a lower GRM represents a better potential investment. Conversely, GRM might be used as a method to determine how much you’re willing to pay for a potential investment. For example, if you’ve determined that you can purchase comparable real estate investments with a GRM of 10, you may determine that the most you’re willing to pay for a property is 10 times annual rents and determine an offer accordingly.
So, let’s take a look at the TWA properties in all their GRM glory. Since I elected to give the properties nicknames, rather than the typical “property no. 1, property no. 2, etc.,” in my first post about the houses, I’ll stick with the names.
| Property | Price | Gross Annual Rent |
GRM |
| The Ranch | $108,000 | $12,900 | 8.37 |
| No Basement | $89,000 | $12,300 | 7.24 |
| The Problem Child | $123,800 | $15,540 | 7.97 |
| The Loft | $112,516 | $16,140 | 6.97 |
And (drumroll please) the Loft wins! Or does it? GRM considers only the price of a property and not necessarily the costs to put the property in rent-ready condition. It also fails to take into account differences in operating expenses, such as maintenance, vacancy rates, and property taxes, which may substantially change the returns from one property to another. Consequently, reliance of GRM as a sole measure of value is incomplete at best. However, GRM can allow you to quickly rule out properties that are priced too high and identify those worth exploring further.
We’ll be returning to alternative measures that will provide further information in evaluating potential real estate investments.
In the meantime, with respect to Four Pillars, here are other important Canadians (although I don’t know who the guy is on the right):
{ 4 comments… read them below or add one }
Hey guys, great post eh??
The guy on the right is Stephen Harper who is our prime minister (ie the president).
Just a note – Mr. Cheap added his reno costs onto his purchase price for the GRM which as you point out is not that accurate if you just use the real purchase price.
Mike
Ah, prime minister. Given the lack of an emmy or similar Hollywood accessory, we were guessing someone in the political arena, although Rob’s guess was some member of the Canadian royal family.
As to Mr. Cheap’s calculation including renovation or rehab costs, I agree that would provide a better comparison of properties, although I have seen GRM defined most often with respect to purchase price. In his article, I believe he was using a list price for purposes of illustration.
I believe Mr. Cheap pointed out that a GRM-type evaluation is at best a “first pass” type of evaluation. I also agree with that. We find GRM useful in narrowing a list of many properties to a somewhat smaller group to inspect. Given that we are looking currently interested in only single-family homes built within the last 10-15 years, we can very roughly estimate a budget range for rehabs. We then factor this rough rehab estimate in doing a quick GRM to narrow the list. I debated on whether to get into rehab costs for the properties in this first post, but decided, for purposes of brevity to address this in a subsequent post on our cap. rate calculations.
Thanks for stopping in and for allowing us to have a little fun with the homeland!
Great post! You’re right that GRM is a first-pass technique (perhaps I should have stressed that more so someone doesn’t run out and buy a property just because it has a good GRM).
Our currency is actually donuts (for lower denominations) and beer.
Thanks for the mention and link!
Donuts and beer. Well, it’s all making sense now. So, we in the U.S. can blame the whole obesity epidemic on NAFTA then.
I’ve been enjoying the Four Pillars posts. Hopefully, we’ll still get to see the occasional post on your northern real estate ventures.