Two income-based ways to value a rental
The income approach values a property by the income it produces. The two common shortcuts are direct capitalization and the gross rent multiplier.[1]
| Direct capitalization | Gross rent multiplier | |
|---|---|---|
| Income used | NOI: after vacancy and operating expenses | Gross scheduled rent, before any costs |
| Market figure | Cap rate from comparable sales | GRM from comparable sales |
| Accounts for expenses? | Yes | No: assumes similar expense levels |
| Best for | Apartment buildings and commercial property | Quick comparisons of similar small rentals |
| Example result | $565,120 | $604,800 |
Gross rent multiplier (GRM)
The GRM method multiplies gross rent by the multiplier on similar sales. Investors usually quote it on annual rent, while the U.S. appraisal report for 2–4 unit properties (Form 1025) multiplies gross monthly rent, so check which one a figure uses; the switch in the worksheet handles both.[3] A GRM expresses a price relationship, not a rate of return,[2] and it ignores expenses, which is why the results also show the cap rate the GRM value implies (5.84% here). The gross rent multiplier calculator covers comparable-sale GRMs in detail.
Where the cap rate and GRM come from
Both figures come from recent sales of similar properties: a market cap rate needs only each comparable's NOI and its reported sale price,[1] and a GRM needs its rent and price. The appraisal form lists the sale price, gross monthly rent and GRM of each comparable for the same reason.[3] Using a cap rate from a different city, property type or year can move the answer by tens of thousands of dollars; see the sensitivity table on the cap rate calculator.
Getting the NOI right
A value is only as good as its NOI. Use actual income and expenses where you can, include vacancy, management and replacement reserves, and leave out mortgage payments and depreciation.[4] The NOI calculator builds the statement line by line.
Not an appraisalThis is an arithmetic estimate, not a valuation for lending, tax or legal purposes. For income over several years with a sale at the end, use the discounted cash flow calculator; to see whether the price works for you as an investor, run the rental property calculator.
Frequently asked questions
How do you calculate the value of a rental property?
Divide net operating income by the cap rate of similar recent sales, or multiply gross annual rent by their gross rent multiplier. $30,000 of NOI at a 6% cap rate is $500,000.
What is a good gross rent multiplier?
A lower GRM means a lower price for each dollar of rent, but GRMs vary by market and property type. Compare a property with similar buildings that sold recently nearby.
Is GRM based on monthly or annual rent?
Investors usually quote it on annual rent. The U.S. appraisal form for 2–4 unit properties uses monthly rent, which gives a number twelve times larger. Divide a monthly GRM by 12 to compare.
Why do the two methods give different values?
GRM ignores expenses and vacancy. If a property's costs are higher or lower than those of the comparables, the cap-rate value adjusts and the GRM value does not.
Sources
- Etter, W. E. Direct Capitalization Versus Discounted Cash Flow Analysis (Publication 1051)
- Etter, W. E. Expected Rate of Return: More than Interest (Publication 1145)
- Small Residential Income Property Appraisal Report (Form 1025 / Freddie Mac Form 72)
- 203.01 Underwritten Net Cash Flow (Multifamily Selling and Servicing Guide, Part II, Ch. 2)