Gross Rent Multiplier: The Rubber Chicken of Commercial Property Analysis

Dike Drummond — Tue, 05 Jan 2010 18:09:59 +0000

Now a Rubber Chicken is pretty useless … except as a practical Joke. Let’s take a look at the most useless number in Commercial Real Estate.

The Gross Rent Multiplier – the Rubber Chicken of Commercial Property Value Indicators.

The Gross Red Multiplier (GRM) is a number you will see on every Broker’s pro forma. And it is touted as a measurement of the “Property’s Value”. If anyone out there really sets a property’s value based on GRM … I have to wonder what they are smokin’. I’m not really sure what a Gross Rent Multiplier measures, but it certainly is NOT the Value of the Property.

GRM is calculated by dividing the Property’s sales price or value by the Gross Potential Income.

Example:
A $1M property with a $100K annual Gross Potential Income. This property has a GRM of 10.

Price (Value) / Gross Potential Income = GRM

$1M / $100K = 10

The GRM number can be thought of as similar to a Price Earnings Ratio for a stock.

The Gross Rent Multiplier is the amount of time it would take you to pay for the property if you were actually collecting the Gross Potential Income and putting it towards the property purchase. For our example property: If you were able to collect that hundred thousand dollars a year and you magically devoted all of it to paying for the property … it would take 10 years for you to complete your purchase.

Beware of the Gross Rent Multiplier.

It can help you compare price between different properties, however, it is absolutely and totally useless as an estimate of value to a returns focused investor. You are focused on the Return on your Investment. You are focused on the Bottom Line. And the GRM is about as much help in understanding your ROI as a Rubber Chicken.

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Since the Gross Rent Multiplier only deals with Gross Potential Income, it is flawed for two main reasons.

1) We’re talking about “Potential Income” based on the Broker’s most optomistic projections of attainable rents. The basic number has no basis in reality – especially if you are looking for a property with upside. Think about it for a second … if the Seller could get these rents for this property they wouldn’t be selling!

2) Gross income starts at the top of the financial statement. For any particular property there is absolutely no relationship between the Gross Income, and the Net Operating Income (NOI) down on the bottom line. You have to know the Real Income and the Real Expenses to understand the actual NOI this property can produce.

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It is only when you understand the Net Operating Income that you can calculate your potential Return on Investment.

Our advice…
Whenever you see the term Gross Rent Multiplier … just ignore it.

And if a promising property shows up … ask for the rent rolls and the financials and figure out the Net Operating Income as best you can. With the bottom line Net Operating Income and potential price in hand, you will be able to calculate your Return on Investment.

With this solid, fact based set of numbers you can make an offer based in reality. Doesn’t mean the Seller will accept it… and at least you start the negotiations with your feet on the ground.

To your investing success,

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Commercial Defaults Rising – Silly Bankers

Dike Drummond — Tue, 13 Jan 2009 00:49:50 +0000

In the January 8th edition of the Wall Street Journal article “Commercial Property Loses Shelter” the author details the rising rates of defaults on commercial loans. The defaults are mirroring the Residential Markets … although the default rates are much lower. Not surprising given the cratering of our economy … and the article goes on to tell us how people got in trouble … this is interesting stuff!

WSJ: “An unusually high number of the underlying CMBS loans that are going bad were made and securitized in the past three years. That is a sign that investors overpaid greatly for those properties and that underwriting standards were loose. In many cases banks lent money based on future income assumptions rather than current cash flows …”

The Lenders committed the Commercial Real Estate Cardinal Sin: they believed in Proforma Numbers.

We have always taught our Commercial Property Mentor clients the rule: NEVER buy on Proforma … and now here we find bankers lending on Proforma numbers. No wonder these loans are going sour in the current economy. You must Always Buy on Actuals!

EXAMPLE: One bad loan quoted in the article was $125M originated when the property’s Net Operating Income (NOI) was $6.3M with the Proforma assumption that NOI would rise to $10.5M. When that didn’t happen … the investors fell behind on payments …. DUH !!! That is a 66% run up in NOI without which the loan does not perform.

The Silver Lining:

In 2009 these properties will come back on the market at a steep discount and you even get a valid “second opinion” on your read of the numbers. Today you can bet the only way a lender will write you a Mortgage it is because they are 100% certain it will make money on Actual Numbers. When the Recession ends, the properties you are able to close now will perform very well indeed.

the-commercial-investor.com » » Investor’s Proforma

Gross Rent Multiplier: The Rubber Chicken of Commercial Property Analysis

Commercial Defaults Rising – Silly Bankers