Education from IrvineRenter----

By Irvine Renter

Gross Rent Multiplier
Was developed by landlords seeking a method to quickly evaluate the purchase price of a property to see if it would be a profitable investment. When performing such an evaluation, a cashflow investor will typically look for a GRM near 100 to find a property with positive cashflow. This method can also be easily adapted to calculate the breakeven point where an owner/occupant would break even compared to renting. As you can see, when you consider the full cost of ownership -- including those costs often ignored -- the gross rent multiplier is lower than most think. The Gross rent multiplier is a convenient measure of value because it spares you the brain damage of performing, detailed calculation for every property you wish to evaluate.


Renting Versus Owning
Renting versus owning is both an intellectual, financial decision and an emotional one. The financial decision is first and foremost an analysis of the comparative cost of renting versus owning. The cost of a rental can be determined fairly easily as there are usually a number of comparable properties on the market to establish a realistic rental rate for any given property. Of course, it is easy to justify in one's mind a comparative rent that is higher than the market will bear. A house someone is in love with will almost certainly rent above market in their minds. Also when looking at similar products the rental rates may not be realistic in the marketplace. It is probably a good idea to take 5% to 10% off comparable rental rates on properties offered on the market. Once you have established what you believe to be a comparative rental rate, and you have gone through a realistic evaluation of the true costs of ownership as outlined above, a simple comparison of the two figures will tell you if a property is overvalued, undervalued or just right.
This point-in-time analysis of the relative worth of a house does leave out a couple of important financial factors: inflation and transaction costs. Inflation is the erosion of purchase power of money over time, or looked at another way, it is the increase in the price of some set of goods and services in a given economy over a period of time. It is measured as the percentage rate of change of a price index. The effect of inflation on housing costs is that it tends to increase the cost of renting over time, and theoretically, it will increase the value of a house over time as well. If the cost of rent is increasing, but your cost of ownership is fixed (assuming a fixed-rate mortgage,) then owning a home becomes less expensive over time and serves as a hedge against the impact of inflation. If you are a homeowner, inflation is your friend. There is one big cost of home ownership that works against the positive impact of inflation: transaction costs. When people buy a house, they pay some closing costs, but many of these get rolled into your loan and forgotten. When people sell a house, they generally go to a realtor to help them market the property and complete the paperwork necessary for the transaction. Real estate commissions for many years have been held at an artificially high 6% in the United States, and the seller is the one who pays this commission. From the time of purchase to the time of sale, inflation (or irrational appreciation) must have increased the value of the house enough for the sales price to cover the real estate commission or the seller will lose money. This is why it is often recommended for people who are not going to live in a given area for more than 2 or 3 years to rent instead of own. Renting is freedom -- freedom to move when you wish (within the terms of your lease.) As I noted in America’s Debtor Prisons, homeowners who go underwater lose this freedom of movement. This advantage of renting is nullified during a price rally as owners have this same freedom during those times, but this forgotten benefit becomes readily apparent once prices start to fall.
Some people spend a great deal of effort evaluating the costs of ownership to determine if is a correct decision, but many people do not. Some people make the decision to purchase the most expensive asset they will ever own with no analysis at all. The decision to buy a house is primarily an emotional one. Even those who go through all the analysis generally only do so to provide rationalizations for their emotional decision. During price rallies, greed becomes a powerful emotion motivating people to fudge their financial analysis in order to justify their emotional purchase. Another factor often called the "nesting instinct" causes both men and women to want a place to call their own, particularly when there are children in the family. There is nothing wrong with deciding for emotional reasons. Most people pick a spouse this way. The real challenge is to have the emotions and the intellect working together to make a decision that is both fiscally sound and emotionally satisfying. This is easier said than done.