Real estate investing requires a deep knowledge about the profitability of commercial real estate property.
Ratios provide investors with objective, measurable, and comparable valuations that provide insight into the day-to-day operations and profitability of commercial property. The Gross Rent Multiplier (GRM) ratio is a commonly used ratio to compare commercial property values.
Review the Gross Rent Multiplier ratio capitalisation method. The GRM approach uses rental income as a proxy for future cash flows.
Gather your data. To use the Gross Rent Multiplier approach you will need the GRM ratio. This can be obtained from a local commercial appraiser or a commercial real estate agent.
Define your variables. For the purpose of this example, let's say you're interested in a commercial office part on sale for £5,850,000 and you want to value the property. Gross rents for the building are £780,000 per year and the appraiser says the GRM for the area is 8.
Calculate the value of the commercial property based on gross rents. Multiply the GRM ratio by the gross rents for the complex. The calculation is: Value of Commercial Property = Annual Gross Rents x Gross Rent Multiplier (GRM). When we plug in the numbers, the equation is: £6,240,000 = £780,000 x 8 (GRM).
Evaluate the results. The office complex is on sale for £5,850,000 and the value of the property is £6,240,000. The valuation shows a profit of £390,000.
Try to validate the GRM for the area through at least three different sources. Review the gross rents calculation and run through scenario analysis to postulate a best- and worst-case valuation based on vacancy. Ask the property manager for a vacancy report for the past two years. Inquire about major construction projects around the site. Understand how this will effect your vacancy rate and/or average rent per square foot.