Gross Rent Multiplier is the valuation metric to be utilized when all you know is the amount of rent a property can generate or believe the expenses (and thus NOI) to be flawed or inaccurate. Gross Rent Multiplier (GRM), which is simply purchase price divided by annual gross rents. For example, a purchase price of $100,000 with gross rents of $10,000 has a GRM of 10. The higher the GRM, the higher the relative rents (and likely more risky income stream).
We see this method applied in distressed investing or when the seller has not been operating a property up to the same standard as the buyer would implement. For example, if the seller was self-managing a property and not paying themselves a management fee and not spending a prudent amount on repairs and maintenance, then the Net Operating Income (NOI) would be flawed, as expenses would be understated, and therefore not a relevant metric to based valuation upon.
This works well for experienced investors who know the level of expenses they would incur by operating a property under their methods. For instance, an investor that owns multiple comparable apartment complexes in the area may know that they can operate a property for X dollars per unit.
For less experienced investors, operating expenses for a rental home for instance, are not all that difficult to estimate. Property tax methodology is available online (as is the actual tax bill in many counties), you can get a property insurance quote from your local agent, and other expense line items such as management fees (if not self managing) and repairs and maintenance allowances, can be responsibly estimated by discussing with other investors or property management companies. With these inputs, NOI can be estimated.
As a general rule of thumb, the less that is known, the greater margin of safety required by an investor. If a seller of an investment property cannot, or will not, produce operating expense figures, let that be a flag to ask yourself what else could be going undisclosed? And what price do I need to justify the extra risk of these unknowns?
Nov 1, 2016