GRM vs. CAP?
I’ve gotten this question from beginner investors lately, and it’s worth a quick explanation. What is GRM and CAP and which is better to use?
GRM stands for Gross Rent Multiple and you get it by dividing the gross rent (the annual total rent from all units in your building) into the purchase price (PP/GR). So a $1M purchase price and $100,000/year in gross rent equates to a 10 GRM. The higher the GRM, the less you cash flow, all else being equal.
CAP is your capitalization rate, which is your net income (gross rent minus all expenses) divided by your purchase price (NI/PP). In this scenario, the higher the number, the more you cash flow.
The benefit of CAP is that it provides more information–that is, if the information is accurate. On larger properties of 8 or more units, you’re more likely to get more accurate information because a management company or a more sophisticated investor has better accounting. However, on smaller buildings of 3-4 units I prefer to use GRM because landlords are generally terrible at keeping and reporting expenses (and they’re fairly easy to estimate), so the only real number is the GRM.
In conclusion, GRM is a great shorthand but doesn’t tell the whole story, and CAP will give you an exact idea of income if you are able to calculate it correctly.
In today’s market in LA, a 4 CAP and 18 GRM are pretty common, but I tend only to show my clients better than 5 CAP or 15 GRM, depending on various factors of course. Email me if you have any questions.