Recently, I stumbled across a national study that mirrors a measurement that I conduct from time to time, and that is comparing the sales price of properties to the going rental rates that these properties could generate as investments.
This method is often referred to as the Gross Rent Multiplier.
The Gross Rent Multiplier is a neat little rule of thumb that will help you anticipate the potential for great long-term returns on real estate investments. The formula for calculating the Gross Rent Multiplier is
Market Value ÷ Annual Gross Income = Gross Rent Multiplier (GRM)
The reason that we measure activity in the Tallahassee housing market so diligently is to find signs that the market is changing, growing, receding, or just doing anything that our customers should know about. For those people who live in Tallahassee and have no plans to move, most of this information is a gross overkill, but to those who are investors or prospective home buyers, knowledge is power.
Tallahassee Housing Market Second Best When Compared To Other Cities In The US
Trulia conducted a simple study that they called a "rent versus buy" index where they analyzed the largest 50 cities in the US. They calculated the price-to-rent (GRM) using the average list price compared with the average rent on 2 bedroom apartments, condos and townhomes listed on their website. While their interpretation of the results were flawed (they claimed that a GRM of 15 was less expensive to own than to rent ... WRONG!), the data that they generated allows an investor to consider one market versus another.
In order to "add" Tallahassee to this study, I used the median rent price from their site with the average price of a similar property in the Tallahassee MLS (see all properties here). I then did the comparison and added Tallahassee to the results of the Trulia study, which are listed below.
US Cities Measured Using Gross Rent Multiplier
|City||State||Avg. List Price||Avg. Rent||Gross Rent Multiplier|
Using Gross Rent Multiplier With Real Estate Investments
Historically, most rental properties in Tallahassee sold for a GRM of less than 9, but when we could find a property that will sell for less than a 7, we knew it could be a "no brainer" investment that would deliver a ROI that would exceed 20% if leveraged correctly. I think most people would agree that an annualized return on investment exceeding 20% would be exciting by today's standards.
The way that I would use the Gross Rent Multiplier would be simple. If a property hit the market that I thought looked promising, I would call my favorite Tallahassee REALTOR® and ask him what he thought he could lease it for on a sustainable basis. Then, using that number and the number for which I could acquire the property, I would calculate my GRM and then make a purchase decision. Not exactly rocket science and a very effective way to conduct property screening.
Why Gross Rent Multipliers Must Now Drop
Unfortunately, historical information must be adjusted in our current environment. Increased property taxes and increased insurance costs are combining to create higher expense ratios when compared to rent. Rents have not risen much (and even have dropped) due to the glut of supply of homes in the Tallahassee housing market.
I would think that an investor wanting to accumulate properties as we come to the low point in home prices should be looking for homes priced at a GRM of no more than 7, but with expectations of finding properties that can be found below 6. Here is a list of properties that very well could hold your next real estate investment in Tallahassee.
Joe Manausa, MBA is a 27 year veteran of real estate brokerage in Tallahassee, Florida and has owned and managed his own company since 1992. He is a daily blogger with content that focuses on real estate analytics and providing his clients with a tactical advantage in today's challenging market.