Agents working with real estate investors will likely do quite a few market value analysis calculations for each property that's purchased. The gross rent multiplier (GRM) is one of them and it's easily calculated, although it isn't a very precise tool for getting to a true value.
It's an excellent first quick value assessment tool, however. It can tell you if further and more detailed analysis is worthwhile.
It probably indicates a problem with the property or gross over-pricing if the GRM is too high or low compared with recently sold comparable real estate.
Why the GRM Matters
Investors who are actively seeking properties often have several on their radar. They have to find a way to quickly rank the opportunities so they can spend their time in deeper analysis of the best options.
The gross rent multiplier hopefully focuses their deeper research into the best options under consideration. But you shouldn't rely on it so much that you don't check out other real estate with better GRMs.
You can get the GRM for recently sold real estate with this equation:
Market Value / Annual Gross Income = Gross Rent Multiplier
If a property sold for $750,000 with $110,000 annual income, the GRM is 6.82.
Use GRM to Estimate Property Value
Let's say that you did an analysis of recent comparable sold properties and found that their GRMs averaged around 6.75, like the example above. Now you want to approximate the value of the site you're considering for purchase. You know that its gross rental income is $68,000 annually. The equation here works like this:
GRM (6.75) x Annual Income ($68,000) = Market Value ($459,000)
You might not want to waste more time considering this purchase if the property is listed at $695,000.
Putting It All in Context
Commercial rental income real estate evaluated based on a number of ratios and lender criteria. Lenders consider the income and profitability of the property as one of the—if not the—most important lending qualification criteria.
They rarely look at or care too about owners' personal credit histories. They might care about the owner's assets if they aren't qualified, however, because they can use those assets to help guarantee the loan.
While commercial lending might have its own qualification criteria, the overall goal is largely the same. The lender wants the business, and they do business by loaning money. From a big-picture perspective, mortgages for commercial real estate are the same as any residential or other mortgages.
Types of Mortgages
Mortgage types used by real estate investors are usually the same as those used by any purchaser of real estate, but there are some more creative financing options available. Investors have a great many alternatives in financing strategies, and the choice can often make or break an investment.
Interest-only mortgage loans allow a real estate investor to defer principal payments. This can help avoid early negative cash flow or provide time to flip the property or adjust rents upward to increase cash flow for regular principal and interest payments.
Blanket real estate mortgages can be a viable financing tool in certain situations. This type of loan can fund multiple properties when the right conditions are present. Of course, there are disadvantages as well. A blanket mortgage can make it difficult to refinance or sell just one of the homes included in the loan because it's something of a package deal.
Finding the best loan for you involves comparing loans such as conventional, jumbo, and FHA/VA, as well as weighing mortgage benefits among fixed-rate, adjustable-rate, and other mortgage alternatives.