Owning rental properties is an excellent way to supplement your income as long as you look at your costs and investments realistically. And the chances that you’ll get a renter is good too with only a 5.89 percent vacancy rate in 2016. Of course, other factors come into play such as property taxes, the reliability of the people, and expenses related to upkeep.
That’s why it’s essential to get a handle on these figures to determine if you’ve priced it fairly and reasonably. Some of these things are beyond your control. It makes sense to start with a baseline and add the rest to your calculations of profit and loss. Properties vary in a myriad of ways. The gross rent multiplier allows you to standardize these figures.
What Is the Gross Rent Multiplier?
The quick answer is that it is a figure that measures what you paid for a rental property versus the monies you earn from renting it out to someone. It doesn’t take into account other aspects of owning it, only the base cost. Other expenses vary widely, so it makes sense to view them on an individual basis for a point of comparison.
The calculation is simple. Take the price you paid for a property and divide it by your annual rental income. It tells you how many years it must be occupied and realizing its full income potential to pay itself off in years. The keywords are occupied and full. It deals with the ideal scenario in which you have no vacancies, and, therefore, no lost income.
For example, let’s say you bought an apartment complex with four units for $100,000. You rented out them and earned $24,000 total. That’s four units times 12 months with $500 to arrive at that figure. If we plug that into the equation, that means you’ll need to maintain this occupancy rate for 4.17 years to get a return on your investment.
100,000 / 4 * ($500 x 12) = 4.17 (rounded up)
The next question is what does it tell us?
How Is It Used?
The word, gross, provides the first clue. It’s not a precise figure, per se. Rather, you can think of it as a comparison of like properties in an area. As you may expect, the lower it is, the better because you’re recouping your investment quicker. It lowers your risk as a buyer and ensures you’ve covered your bases. That is the motivation behind house flipping too.
The opposite is true if you’re selling the property. In that scenario, it’s better if it’s higher because a buyer will hold onto the property longer and, in turn, take on the burden of the upkeep costs.
This figure uses annual data rather than monthly rent. If you know what it is up front, you can calculate a conservative property value too. You can also figure out what you need to charge for rent to recoup your costs within a comfortable interval. The cost of the site doesn’t give you enough information to make this buying decision. That’s where this calculation exceeds.
Both sellers and buyers of rental properties use it because it offers advantages to each one. The vacancy rate is a major factor, so you need to consider the location of the property while making your assessment. Think about the factors that drive people’s decisions to rent someplace such as access to schools, amenities, and transportation.
The number itself isn’t useful beyond the scope of the area where you’re considering buying a property. It doesn’t transcend to different markets. For example, you’ll likely find that the elements will vary considerably in an urban location versus one far from shopping and public transportation access. Likewise, a property on the water will command a higher rent.
What You Need to Know
The price of the property is the first essential figure that you need to know. Even if you don’t have it, you can find what similar properties have sold for to arrive at a starting point. Then, there is the income. Some sites earn more money than simply the monthly rent. You need to consider them as well in the equation.
Pros and Cons of the Gross Rent Multiplier
Other Factors Affecting Investment Decisions
If these were the only things you needed to know, you’d be set. But it’s not that simple. You must consider other expenses that can affect your bottom line. They include:
You can get a property at a steal to give you a low gross rent multiplier. However, if the property needs a lot of work, you’re going to have to invest a chunk of change to make your investment worthwhile. That will add to the number of years that you must have it earning its full scheduled income potential.
You also have to consider what you can reasonably expect to get for monthly rent. The median rent was $981 in 2016. But it varies widely by state, city, and location. The latter is especially important with desirable features such as water access.
Then, you must consider vacancy rate since that will directly impact the gross rent multiplier. In the United States, these figures by region were as follows in 2017:
- Midwest: 7.6 percent
- West: 4.5 percent
- Northeast: 5.5 percent
- South: 8.8 percent
It’s worth noting that the Northeast has been the most consistent in the last several years. All the others have been widely variable with swings that have nearly doubled from 2000 through 2017. Of the four, the West has been the most unpredictable and seemingly most vulnerable to the impacts of the 2008 recession.
All regions have stabilized in the last four years. However, it’s essential to pay attention to the swings in the stock market to gauge the risk of your investment. But as Will Rogers once said, “Buy land. They ain't making any more of the stuff.”
The gross rent multiplier gives you a foundation from which to start when considering which properties are worth your investment. It looks at a site based on its face value without taking into account other expenses that can affect it to varying degrees. You can think of it as a line item in your pre-sales analysis. It is, after all, a conservative estimate of what you should charge.
Its value is as a screening tool to narrow down the playing field before you do some more serious research. You’ll have a good negotiating tool to get you a better deal on a property whether you’re buying or selling.