A two-number screen that ignores the two numbers that decide value, and the one-line formula that converts it into a cap rate.
The gross rent multiplier is the price divided by the gross annual rent: a building bought for 12,000,000 with 1,200,000 of gross potential rent trades on a GRM of 10.0x. The trouble is what the multiplier leaves out. Two buildings on the same 10.0x can sit on cap rates of 5.98 and 8.92 per cent, 294 basis points apart, because the GRM never sees vacancy or operating costs. Convert it with cap rate = (1 − vacancy) × (1 − cost ratio) ÷ GRM before you use it to price anything.
Worked in full in Commercial Real Estate Investing by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The GRM is popular because it needs only two numbers, both of which appear on the first page of any sales particulars. It is a fair screen for buildings that run the same way, such as a row of similar apartment blocks in one town. Across lease types it is unreliable, and the arithmetic below shows by how much.
Two illustrative buildings, each offered at 12,000,000 with 1,200,000 of gross potential rent. Building A is a multi-let office on gross leases, so the landlord pays most of the running costs. Building B is a single-let warehouse on a net lease, where the tenant pays them.
| Input | A: multi-let office | B: let warehouse |
|---|---|---|
| Price | 12,000,000 | 12,000,000 |
| Gross potential rent | 1,200,000 | 1,200,000 |
| Gross rent multiplier | 10.0x | 10.0x |
| Vacancy and collection loss | 8% | 3% |
| Non-recoverable costs, share of effective income | 35% | 8% |
| Buyer's required cap rate (illustrative) | 6.50% | 6.50% |
GRM = price ÷ gross annual rent
NOI = gross rent × (1 − vacancy) × (1 − cost ratio)
Cap rate = NOI ÷ price = (1 − vacancy) × (1 − cost ratio) ÷ GRM
In Excel, with price in B2, gross rent in B3, vacancy in B4 and the cost ratio in B5: =B2/B3 for the GRM and =(1-B4)*(1-B5)/(B2/B3) for the cap rate it implies. The bracketed product is the share of every unit of gross rent that reaches NOI; call it the NOI ratio.
| Line | A | B |
|---|---|---|
| Gross potential rent | 1,200,000 | 1,200,000 |
| Less vacancy and collection loss | -96,000 | -36,000 |
| Effective gross income | 1,104,000 | 1,164,000 |
| Less non-recoverable costs | -386,400 | -93,120 |
| Net operating income | 717,600 | 1,070,880 |
| NOI ratio (NOI ÷ gross rent) | 59.8% | 89.2% |
| Cap rate at 12,000,000 | 5.98% | 8.92% |
| Effective gross income multiplier | 10.87x | 10.31x |
Check A with the one-line formula: (1 − 0.08) × (1 − 0.35) ÷ 10 = 5.98 per cent. The gross yield, the GRM turned upside down, is 10.0 per cent on both. On the office, four tenths of that gross yield is spent before the owner sees it.
Turn the formula round to find the highest GRM a buyer can pay and still earn the required cap rate: maximum GRM = NOI ratio ÷ required cap rate.
| Building | Max GRM | Value at 6.50% | Asking less value | Over or under |
|---|---|---|---|---|
| A, multi-let office | 9.20x | 11,040,000 | 960,000 | 8.7% over |
| B, let warehouse | 13.73x | 16,475,077 | -4,475,077 | 27.2% under |
At the same 10.0x, the office is 960,000 too dear and the warehouse 4,475,077 too cheap for a buyer who needs 6.50 per cent. A GRM screen would have ranked them equal. The difference is entirely in the cost line: every point of cost ratio on the office moves its cap rate by 9.2 basis points and its value at 6.50 per cent by 169,846.
The GRM is measured on gross potential rent. If one broker quotes rent as passing and another as fully let at market, the multipliers are not comparable even before costs. The effective gross income multiplier, price over income after vacancy, removes that problem but still ignores costs: 10.87x against 10.31x here, still nowhere near the 294 basis point gap in the cap rates.
The grid gives the cap rate each multiplier implies across cost ratios, at a 5% vacancy allowance. Read along a row to see how much of the answer the GRM is not telling you.
| GRM | Costs 10% | Costs 20% | Costs 30% | Costs 40% |
|---|---|---|---|---|
| 8x | 10.69% | 9.50% | 8.31% | 7.12% |
| 10x | 8.55% | 7.60% | 6.65% | 5.70% |
| 12x | 7.12% | 6.33% | 5.54% | 4.75% |
| 14x | 6.11% | 5.43% | 4.75% | 4.07% |
A 12x net-leased building at 10 per cent costs yields exactly what an 8x gross-leased one at 40 per cent costs yields: 7.12 per cent each, although one multiplier is half as high again as the other. The multiplier a 6.50 per cent buyer can pay runs from 13.15x at 10 per cent costs to 11.69x at 20, 10.23x at 30 and 8.77x at 40. A rule of thumb such as "never pay more than 10x" is therefore a rule about cost ratios, whether or not the person quoting it knows that.
The fix is a single extra line: build NOI from the rent roll and the cost budget, as in how to calculate NOI on a commercial property, and compare cap rates. Whether the resulting cap rate is high enough is a separate question, answered in what is a good cap rate for a commercial property.
GRM = price ÷ gross rent, and cap rate = NOI ratio ÷ GRM. The same 10.0x is a 5.98 per cent office and an 8.92 per cent warehouse; priced at 6.50 per cent, one is 8.7 per cent too dear and the other 27.2 per cent too cheap. Use the GRM to sort a list, then convert it. Commercial Real Estate Investing sets six different entry yields side by side for one estate and shows which of them can be compared with an exit yield; the free workbooks for this case build the income account from the rent roll up.
There is no universal figure, because the GRM a buyer can afford depends on how much of the gross rent survives costs. Divide the NOI ratio by the required cap rate: at a 6.50 per cent requirement and 5 per cent vacancy, a building with 10 per cent costs supports 13.15x, one with 40 per cent costs only 8.77x.
The GRM divides price by gross rent; the cap rate divides NOI by price. The cap rate therefore includes vacancy and operating costs and the GRM does not. Two buildings both at 10.0x here show cap rates of 5.98 and 8.92 per cent, a 294 basis point gap the multiplier cannot see.
The standard GRM uses gross potential rent. Using income after vacancy gives the effective gross income multiplier, 10.87x and 10.31x for the two buildings here. It corrects for vacancy but still ignores operating costs, so it does not replace a cap rate built on NOI.
This article is one calculation from Commercial Real Estate Investing. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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