The gross revenue multiplier (GRM) is used to quickly evaluate a property’s value. It is used to compare similar homes, and also can be a persuasive tool for showing renters the value of homeownership.
The American Dream of homeownership has a strong pull on renters, and yet, many believe they simply can’t afford to buy.
But with rents exceptionally high across California, real estate professionals are increasingly able to make the argument that some renters can’t afford not to buy. So, what’s the best way to show buying is better for a renter’s wallet than renting?
One good way to decide whether the renter is better off financially renting versus buying is to consider each property’s price-to-rent ratio.
This rule-of-thumb, more commonly referred to as the gross revenue multiplier (GRM), is used to quickly evaluate the value of a property. A home’s GRM is calculated by dividing the asking price for a residence by the annual rent it or a comparable property commands. For example:
List price: $480,000 / Annual rent: $24,000 ($2,000/month x 12 months)
In this case, the GRM ($480,000 / $24,000) is equal to 20.
What is a good GRM?
In the example above, is 20 a “good” GRM?
20 is a figure suggested by New York Times reporting as the tipping point for an acceptable GRM. Anything higher than 20 means renting will end up being cheaper in the long run than purchasing. Anything lower than 20 means the renter will save money each year — the lower the GRM, the more money they will save.
Variations in mortgage rates inversely alter this ratio. As interest rates rise, a lower GRM is necessary due to more money being paid toward interest each month.
Further, in many high-end neighborhoods and coastal communities, it makes more financial sense to rent than to buy based on a GRM of 20, or even a more prudent 15 for that matter. The figure of 20 suggested in the New York Times is a national figure, and not applicable everywhere in California.
The best way to learn what an acceptable GRM figure is in your community is to use the GRM measure on a number of homes in close proximity to each other. Once you determine what the average GRM is for the type of home your client is interested in, you can compare to see what a “good” GRM is versus an unacceptable GRM.
On its face, the GRM is a simple calculation only needing two figures: a property’s asking price and its comparable annual rent. But in reality, a property’s facts and figures are significantly varied, including differences in:
- utility costs;
- property taxes;
- maintenance costs;
- landscaping expenses;
- appreciation, to be realized upon resale; and
- tax benefits or savings.
To get into these figures, potential homebuyers can use a buy-versus-rent after-tax analysis. [See RPI Form 320-4]
When filling out this form, use real numbers from the potential property to be purchased. Actual numbers will ultimately speak louder than estimates or abstractions. As the homebuyer will see, the biggest savings from homeownership are gained in tax savings — the mortgage interest deduction (MID), a direct government subsidy to encourage homeownership. Then, as the homeowner continues to own their home over several years (and pay less on interest each month as the mortgage amortizes), their growing equity and home value appreciation take over as the primary source of savings.
Doing this math helps the homeowner realize that even when they may end up paying more on homeownership costs each month compared to renting, they may still save more money over the course of a year or longer.
Once the renter sees the financial advantages to buying versus renting, the only obstacle in their way to homeownership is now coming up with a down payment and money to close and move.
Again, here they may be more worried about finances than they need to be. One-in-three potential homebuyers reported they believed a 20% down payment was required, according to Freddie Mac. As any real estate professional knows, a 20% down payment is needed to eliminate costly mortgage insurance, but it is not a general requirement. Homebuyers can put as little as:
- zero down for a U.S. Department of Veterans Affairs (VA)-guaranteed mortgage;
- 3.5% down for a Federal Housing Administration (FHA)-insured mortgage; or
- 5.0% down for a conventional mortgage.
This misconception means a big chunk of potential homebuyers (roughly 33% according to the Freddie Mac survey) feel the need to save much longer than they need to in order to qualify.
Agents: Use the GRM to quickly evaluate property and consider teaching your more self-reliant and savvy homebuyer clients about this simple calculus they can perform themselves. For a simplified version of the buy-versus-rent analysis above, see the marketing FARM letter, which is free to download and personalize: Buy Versus Rent Comparison Analysis.