Gross Rent Multiplier
Suppose you want to buy an apartment building or obtain a commercial loan on a multifamily property. You can quickly compute the value of any multifamily property, if you know that property’s Gross Scheduled Rent and the correct Gross Rent Multiplier for that area. The Gross Rent Multiplier is a number, usually between 3 and 11, by which you multiply the Gross (Annual Scheduled) Rents to obtain a rough estimate of the value of an apartment building. Expressed algebraically:
Value of an Apartment Building = Gross (Annual Scheduled) Rents x Gross Rent Multiplier
You’re in a car with your commercial broker, and the two of you are driving around a good rental area in your city, looking for an apartment building to buy. You come to a decent looking building that is for sale. Your commercial broker looks up the Gross (Annual Scheduled) Rents and tells you that they are $263,000 per year. “What’s the going Gross Rent Multiplier for this area?” you ask him. Around seven,” he replies. You multiply $263,000 by 7 to compute a market value of $1,841,000. “What’s the seller asking?” you ask your broker. He replies, “$2,670,000.” “Ha-ha,” you laugh. The seller is on drugs if he thinks that he is going to get that much.” You find another nice building. “What are the Gross Rents of this property?” you ask. “$301,000,” replies your commercial broker. You multiply $301,000 times 7 to arrive at a market value of $2,107,000. ‘What’s the seller asking?” "$1,995,000.” “This looks like a decent value. Let’s get out and walk around,” you reply with interest.
You’re a commercial mortgage broker. A borrower calls you looking for a $3 million multifamily loan. He owes $2,850,000 on the property, and the loan is ballooning. “What’s the building worth?" you ask the borrower. “$4.25 million," he replies defensively. Instinctually your radar flashes a warning. “He’s lying,” you think to yourself. “What are the gross rents on the building?” you ask the borrower. "$473,000,” he replies guardedly. You’ve lived in Las Vegas your entire life, and there’s a ton of vacant land surrounding the outskirts of the city. The Gross Rent Multiplier in Las Vegas has never exceed 5.5. Five point five times $473,000 equals just $2,600,000. Just $2.6 million? Heck, the borrower owes $2.85 million. This deal is a loser. “Who has turned you down on this deal already?” you ask. “Boston Nation, Pebble Stream Capital, and San Diego Apartment Express.” he replies, naming the three most aggressive multifamily lenders in the market. “Can you bring a load of cash to the closing table?” you ask. “No,” he admits. “Do you own some other property that we can refinance?” “No, just my house, and its has an 80% LTV loan on it.” “I’m sorry, Mr. Borrower, but I can’t help you. You need to do a short sale.” By understanding and knowing the Gross Rent Multiplier, you just saved yourself six weeks of wasted work.
In each of the two examples above, you already knew what the proper Gross Rent Multiplier to use. In the first example, your commercial broker knew the proper Gross Rent Multiplier for that area. In the second example, because you were an expert on multifamily loans in Las Vegas, you already knew the proper Gross Rent Multiplier to use. But how do you determine the proper Gross Rent Multiplier for an area?
How To Compute the Proper Gross Rent Multiplier
To compute the proper Gross Rent Multiplier for any given submarket, neighborhood, or area, you will need some recent Sales Comparables and the Gross Rents of each apartment building at the time it was sold. This is easier than it sounds. It is quite common for the listing broker to prepare an online sales brochure on the multifamily property being marketed for sale, and once the sales brochure is posted online, it is rarely taken down. . Start by asking some local commercial brokers for the addresses of any recent apartment sales. When you type that address into Google, you’re likely to find the original online sales brochure, along with a Pro Forma Operating Statement, which will list the Gross Rents. If the sales brochure does not happen to say, “Sold for $2,460,000,” the listing broker’s name will appear on the sales brochure, and you can just call him.
Here is the formula for computing the Gross Rent Multiplier:
Gross Rent Multiplier = Sales Price / Gross Rents
What is the Gross Rent Multiplier for apartments in northwest Chicago? After looking at an old sales brochure, you see that a particular 24-unit apartment building had a Gross Annual Rent of $532,800. You call the listing broker, and he tells you that the building eventually sold for $4,928,000. At what Gross Rent Multiplier ("GRM") did this 24-unit apartment building sell?
Gross Rent Multiplier = Sales Price of the Apartment Building / Gross Rents
GRM = $4,928,000 / $532,800
GRM = 9.25
Getting a Feel For a Reasonable Gross Rent Multiplier
As indicated above, the typical Gross Rent Multiplier will be some number between 3 and 11. The nicer the building and the nicer the area, the higher the Gross Rent Multiplier. Gross Rent Multipliers of 11 or higher are almost unheard of outside of Silicon Vally, New York City, Washington, D.C., and the very best areas of Chicago. Most apartment buildings in the real world will sell today at GRM's of 6 to 8.
Some apartment lenders split up multifamily projects into three tiers - Tier I, Tier II, and Tier III. The buildings in Tier I are the nicest and hence qualify for the lowest rates. But how can you determine into which tier an apartment building falls. On purchase money deals, the Gross Rent Multiplier will give you a clue.
Tier I Apartments: Buildings selling at a GRM of 10, 11, or higher.
Tier II Apartments: Buildings selling at a GRM of 7, 8, and 9.
Tier III Apartments: Buildings selling at a GRM of 4, 5, and 6.