I’ve learned from experience that it’s risky to dive into a rental property deal without evaluating its profitability first with certain real estate metrics. There are a few that I keep in my back pocket when I’m assessing a property; these are formulas for calculating the gross rent multiplier (GRM), net operating income (NOI), and the internal rate of return (IRR).
Seasoned real estate investors use these metrics consistently to determine a property’s financial performance and overall profitability. It’s well worth the time taken to crunch the numbers because it can mean the difference between either spending your hard-earned money on a property that produces a high return on investment or something that will land you in the red. Ok, now that I have your attention, let’s get started…
Essential Real Estate Metrics for Investors
I know these real estate metrics may sound a bit confusing, but once you read my article, you’ll have a better understanding of what is GRM, NOI, and IRR in real estate, which will help place you on the path to building wealth the right way. I’ll begin by breaking down the GRM formula, its purpose, and the steps needed to calculate it.
1. Gross Rent Multiplier (GRM): Definition, Calculation, and Significance
Ok, so what is GRM in real estate investing? Well, it’s a screening tool that’s commonly used when estimating a rental property’s potential profitability based on its rental income. Here’s a more in-depth description: The gross rent multiplier is a ratio that contrasts a rental property’s current market price against its gross yearly rental income.
The bottom line is that the GRM calculation should reveal how many years it would take for the property’s rental income to cover its purchase price. This, in turn, provides an idea if the purchase price of the property works well with the average rental income that can be charged.
Along these same lines, be sure to bookmark my other GRM article for additional information: Maximizing Rental Income: Understanding Rent Comparables and Gross Rent Multiplier.
Whether a property is worth your time or not would depend on whether the GRM metric is high or low. Why? Because the final number represents the number of years it takes to pay the property off. GRMs that are on the high end could indicate that the property is overpriced. In contrast, a GRM that’s on the lower end would reveal that it might be a good deal and worth the investor’s time and money.
What’s a Good GRM for Rental Properties?
There’s really no “one good number” when it comes to the final GRM calculation, and this is because there are too many factors and variations among different housing markets. Each market and neighborhood will most likely have a different GRM result. Plus, the final GRM is commonly used to compare one property to others, so having one standardized “good” and “bad” GRM number wouldn’t make sense.
For example, when using a GRM metric to compare different properties in the same area, if the property you’re interested in has a GRM of 10 and various nearby rental properties have a GRM of 6, then you should move on. Having such a high GRM as 10 when others are much lower tells you the property is overpriced and you’ll have a lower return on investment.
The GRM Formula
Now that you know the significance of using this real estate metric, let’s take a look at the actual formula. It’s pretty simple to calculate, as seen below:
Gross Rent Multiplier (GRM) = Property Value / Gross Rental Income
To better understand how the formula works, I’ll provide a simple example: An investor is looking into a possible rental property that has an asking price of $350,000. It’s estimated that it will reel in $2,800 per month in rental income, which comes to a yearly rent of $33,600. Using these numbers, the formula looks like this:
$350,000/$33,600 = 10.4 GRM
The gross rent multiplier comes to 10.4 GRM, which means the payoff timeframe would be a little over 10 years. The investor would take this number and compare it to similar properties in the area. If they find that other comparable houses have a higher GRM, then they may have a possible good deal on their hands.
If you’re interested in calculating more numbers to check if a property is worth buying or not, I recommend my other article – Analyzing Rent to Price Ratio: Metrics, Significance, and Application.
Now that you have a better understanding of what is GRM when it comes to rental property investing, we can move on to the next real estate metric, which is IRR:
2. Internal Rate of Return (IRR): Explanation and its Impact on Investment Decisions
The next metric on the list is the internal rate of return (IRR). Using IRR in real estate decisions is common, and I know many seasoned investors who would never even think of entering a deal without first determining the return with this calculation method.
So, what is IRR? In simple terms, it’s a financial metric used to find the annual rate of growth expected on a rental property, or other investment. Another way of phrasing it would be that an IRR is utilized to evaluate the profitability of a rental property over time.
Why Investors Use IRR Real Estate Metrics
IRR in real estate is mostly used on properties that are financed, while ROI, a metric you may be familiar with, is commonly used in a cash-based purchase model. Financing a deal, which is also phrased as leveraging your money, typically provides much larger returns, and is what I always recommend. I mentioned ROI, and if this is a term you’re not familiar with, then feel free to dive into the following post I put together – ROI Calculator for Real Estate.
So, why would an investor be interested in using IRR metrics? Let’s find out below:
- Allows for More Strategic Decision-Making: Instead of diving into a deal blind, calculating the IRR helps investors fine-tune the decision-making process by letting them know if the property will meet their required rate of return.
- IRR Metrics are Used to Evaluate Profitability Over Time: Taking into account three main elements, which are cash flow, principal reduction, and property appreciation, the internal rate of return can provide an investor with important details on the long-term profitability of an investment.
- Compare Investment Properties: By calculating the IRR for different properties, investors can identify the one that offers the highest potential return.
The IRR Formula:
Below, you’ll find the IRR formula, which can look a bit intimidating:
A brief description of the main elements:
- CFt is the cash flow over period t. (The CF0 is generally negative if it represents the initial investment).
- r is the discount rate, or in this example, the IRR.
- t is the time period (from 0 to n).
As you can see, the formula for calculating the internal rate of return is fairly complex. Because of this, I’m sharing an IRR calculator that you can plug your numbers into – IRR Online Calculator.
So, what should you be shooting for when it comes to a final IRR metric? I would say 18%, and you might not find that with most turnkey investment companies, but Morris Invest provides 18+% on our new construction rental properties. If you have any questions regarding what your internal rate of return would be if a property was obtained through us, feel free to book a complimentary call.
3. Net Operating Income (NOI): How it’s Calculated and its Importance
Net Operating Income (NOI) is another real estate metric that provides an inside look into a rental property’s financial performance and potential return on investment. It’s a simple calculation where the total revenue (rent) is subtracted from the operating expenses (repairs, insurance, etc.) while leaving any debt and taxes out of the equation.
With this real estate metric, an investor can compare property profitability or simply determine if it’s financially wise to move forward on a deal or not. Here’s the simple formula that’s used to calculate NOI:
Net Operating Income = RR – OE
(RR: Real Estate Revenue, OE: Operating Expenses)
Using a simple example, if an investor has a property that produces an annual income of $42,000 and has operating expenses that total $27,000, the net operating income (how much you have leftover) would be $15,000.
Determining whether a net operating income is favorable or not depends on several factors, including the property’s purchase price, market conditions, investment goals, and comparable properties. NOI alone doesn’t tell the whole story; it’s more of a starting point to get an idea of whether a property is worth pursuing or not.
You can utilize this online NOI Calculator to find your net operating income.
Power Resources for Real Estate Investors
Before I wrap things up here, take a moment to check out our power resources, or bookmark them for future reading:
I’m also including a few more real estate metric articles that you can dive into:
- Evaluating Rental Property Performance By Calculating Cash-On-Cash Return
- A Comprehensive Look at How to Calculate Rental Property Depreciation
- Rental Property Metrics: Rentometer, Rent Estimates & Rent Roll
- Real Estate Valuation – Methods for Determining a Property’s Worth
Add Rental Real Estate Metrics to Your Investment Strategy
Understanding what is GRM, NOI, and IRR in real estate is one step in the right direction to ensure you make the right investment decisions. As I mentioned earlier, it’s never a wise idea to move forward with a deal without the metrics; you should always have numbers that back up your decision to purchase.
This is where real estate metrics, GRM, NOI, and IRR become your safety net. Of course, these metrics shouldn’t be utilized as a final decision maker, but as a starting point that lets you know if you should walk away or push forward with a potential rental property purchase. These metrics can save you time and money, so be sure to keep them handy.
For those who would like to skip to the chase and not have to worry about metrics and calculations to determine profitability, know that Morris Invest can do all the work for you. We build new construction rentals that pass all the metric tests, and even come out on top compared to other turnkey companies. Remember, our properties typically produce an 18+% IRR which is exceptional.
Feel free to schedule a complimentary call if you have any questions or would like to hear about our rental properties. Also, it’s worth mentioning that we can take care of everything for you when placing a rental property into your portfolio. This includes assigning an experienced property manager as well as placing a tenant in your rental – we make it super simple to start building wealth.
Here’s a video I put together that covers IRR as well as ROI metrics:
