Quite simply, the gross rent multiplier is a property’s price divided by its gross annual rents.

Put another way, the gross rent multiplier tells you how many years it would take for a property’s gross rents to pay for itself.

Keep in mind that gross annual rents are exactly that: the gross number, not including any expenses. That leaves the gross rent multiplier (GRM) a rather crude ratio since property expenses vary wildly from market to market and from property to property.

Example Numbers

Imagine Gina is considering a property priced at $180,000. The monthly rent is $1,500, which means the annual gross rents are $18,000.

Gina could find her GRM by following this equation:

$180,000 purchase price / $18,000 annual rental income = 10 GRM

In a perfect world with no expenses, it would take ten years for the rents to pay for the property in this hypothetical example.

At the risk of stating the obvious, a lower number is better when it comes to GRM.

Easy enough, right?

Note that if Gina negotiates a better deal and buys the property for $165,000, the GRM changes to 9.17 ($165,000/$18,000 = 9.17). Alternatively, say Gina pays the full $180,000 but forecasts that she can raise rents to $1,600/month with a few minor cosmetic tweaks. That changes the math as well: her gross annual rents would then change to $19,200, so her GRM changes to 9.38 ($180,000/$19,200 = 9.38).

Those are the only two numbers that can change the gross rent multiplier: the property price and the collectible rent.

As a ratio of a property’s rent to its price, the Gross Rent Multiplier it’s a loose indication of income yield. Theoretically, the better (i.e. – the lower) the ratio, the better the investment.

Ever heard of the “2% Rule” or the “1% Rule” in real estate investing? These rules of thumb compare the property’s monthly rent as a percentage of its purchase price. Investors following these rules look for properties that rent for at least 2% (or 1%) of the purchase price.

Gross rent multiplier is simply another way of measuring the same relationship between rent and price.

RELATED: Real Estate Basics: How Rental Properties Make Money

You can think of the gross rent multiplier as a “screener metric.” If you’re browsing through dozens of properties for sale, you can calculate the GRM for each property in just a few seconds. When the GRM is outrageously high, you can dismiss that property without devoting another second to it.

Similarly, you can use GRM to evaluate neighborhoods and even entire cities on their price/rent ratio. For example, imagine you live in San Francisco, where the median GRM is an atrocious 26.06 according to Zillow. (In case you’re curious, the Zillow Home Value Index is $1,359,800 at the time of this writing, and the Zillow Rent Index is $4,348. Not pretty for investors.)

So, you set out to find a city with a more reasonable GRM and settle on Indianapolis. It boasts an affordable average home price of $166,800 and an average rent of $1,238, putting its GRM at 11.28.

From there, you can zoom in to the neighborhood level and compare gross rent multipliers and cap rates there. Follow this long-distance real estate investor’s survival guide if you plan on investing from afar, and consider a platform like Roofstock to make it easier.

RELATED: Roofstock Review: Is This the Easiest Way to Buy Turnkey Rental Properties?

Imagine you find a neighborhood where most properties have a gross rent multiplier of around 7. But the property you’re evaluating has a GRM of 5. That tips you off that there is some reason why this property is priced more attractively; for example…

• It might need significant repairs
• It might have an outdated layout
• It might be situated directly over a subway line so the house shakes every ten minutes when trains pass underneath.

But because the GRM is an outlier, it tips you off that something is forcing the seller to reduce the price to lure buyers.

You can also use the gross rent multiplier to estimate a property’s value (in very broad strokes).

Say you’re looking at a different property in the same neighborhood above, with an average GRM of 7.

This other property is unique: instead of a single-family home like most in the neighborhood, it comprises a single-family home, a detached garage with a livable apartment above it, and a detached guest house.

After running the numbers on market rents, you determine the single-family house could rent for $1,000, the guest house could rent for $700, and the garage apartment could rent for $500. You can then multiply the annual gross rents ($26,400) by the neighborhood’s typical GRM (7) to reach a rough value estimate of $184,800.

If the seller is asking $160,000, then it looks like a good deal (on paper, at least). But if they’re asking $300,000, then it’s likely not a good deal, barring other variables.

The problem with gross rent multipliers is that it ignores expenses and other challenges that vary from neighborhood to neighborhood or property to property.

Consider an easy example. In Neighborhood A, the GRM is 10, while in Neighborhood B, the GRM is 11. On the surface, it would seem Neighborhood A is the better investment. But then you discover that the vacancy rate is twice as high in Neighborhood A, as are the turnover rates and crime rates.

The higher vacancy rates mean that your cash-on-cash return is actually lower in Neighborhood A, despite the better GRM. Equally bad, the high turnover rates and crime rates mean far greater headaches and labor as a landlord in Neighborhood A.

This is precisely why lower-end real estate often looks good on paper, but in reality, comes with lower returns and more headaches as an investor.

As touched on above, capitalization rates (cap rates) include expenses. The gross rent multiplier does not.

While the gross rent multiplier only analyzes the purchase price and gross rents, cap rates go further to use net rental income. They account for expenses like:

• Vacancy rates
• Property taxes
• Property insurance
• Property management fees
• Maintenance
• Repairs and capital expenditures (CapEx)
• Bookkeeping, accounting, legal, and other ownership expenses

That makes cap rates significantly more precise than GRM. And, of course, significantly more involved to calculate.

I would also posit that on a city or neighborhood level, cap rates are suspicious. Yes, they may all be subject to the same property tax rate, but other expenses often prove too variable to just apply sweeping, assumed expense numbers to them.

With the gross rent multiplier, you know exactly how limited it is when you use it to evaluate cities or neighborhoods. It’s a blunt tool. But while cap rates are more precise, the nuances get lost when applied citywide or even neighborhood-wide.

Use GRM for large-scale, blunt-tipped research. Then gradually get more precise as you narrow in on specific neighborhoods and properties, eventually going down to the level of a property’s exact cash-on-cash return.

The cash-on-cash return of a property is a far more precise measurement – and consequently takes more time to calculate accurately.

To reach it, investors must plug in their exact cash investment, the gross rent, and all expenses with high accuracy. Financing impacts cash-on-cash return, both on the basis of down payment and monthly mortgage payment.

Consider two properties, both costing $180,000, and both renting for $2,000 gross. They share the exact same GRM of 7.5.

But they could have vastly different returns. Property A is a good neighborhood with low vacancies, low turnovers, and low property management fees. The lender offers you 80% financing at an attractive interest rate, leaving your total monthly expenses at $1,500, and annual net cash flow of $6,000. That puts your down payment at $36,000, and your cash-on-cash an impressive 16.7%.

Property B is another matter entirely. It’s in a lower-end neighborhood, with high vacancy rates, high turnover rates, and higher property management fees (especially given the higher frequency of having to pay new tenant placement fees). The lender only offers 75% financing, and at a higher interest rate. In this case, your total monthly expenses are $1,700, leaving an annual net cash flow of $3,600.

With a down payment of $45,000, your cash-on-cash return is 8%. That’s less than half the return of the other property – despite sharing the exact same gross rent multiplier.

By now it should be clear that a gross rent multiplier by itself does not offer enough insight into a property’s returns. That said, there are a few broad trends worth mentioning for GRM.

On a city-wide level, a good gross rent multiplier ranges from 8-12, roughly speaking. It demonstrates that it is possible to find good deals that cash flow well in that market.

But on a property level, aim for a lower GRM. As a real estate investor, you aren’t looking for average; you’re looking for deals. Many investors consider a GRM of 4-7 to be “good” for rental properties. Again, keep in mind that on the property level, you should be going far beyond GRM to evaluate cash-on-cash return.

Gross rent multiplier works best as a broad screening tool: a way to identify cities, neighborhoods, and properties that show promise for rental investing.

As you drill down to specific neighborhoods, start aiming to use cap rates for more insightful data, even as you acknowledge that they won’t be perfectly accurate. But they help you identify neighborhoods to research in even more depth. Use a tool like Mashvisor for neighborhood-level cap rate data.

RELATED: What Can Mashvisor Do For Real Estate Investors?

Finally, on the property level, use GRM to screen out obvious losers. Among the remaining prospects, you can then dig deeper and start running more exact numbers like cash-on-cash return.

Yes, gross rent multiplier is a blunt-force tool. But as any sculptor would agree, you need blunt tools in your toolkit, particularly as you’re making your first pass at a property. They help you chisel away the large chunks, so you can focus on the finer details with more precise tools.