Leverage (Finance)

Leverage is the use of borrowed money to control an asset larger than your cash alone would buy. It magnifies the return on your equity when the asset earns more than the debt costs and reduces it when the asset earns less. Gross rent multiplier does not reflect leverage at all; it describes the property before any loan.

Whether leverage helps depends on the property's cap rate against the loan's annual cost, about 8.2% for a 30-year loan at 7.25%. Under typical expenses a GRM around 7.5 or lower implies a cap rate above that line, where borrowing helps. Above a GRM of about 7.5, borrowing hurts and more of it hurts more.

That makes GRM a rough leverage screen even though it knows nothing about the loan. A GRM of 6 property can carry high leverage and still cash flow. A GRM of 12 property loses money on every borrowed dollar at current rates, and its investor is betting on appreciation. The multiplier cannot say which is the better bet; it can say which one the bank will be happy to finance.

Further reading: Leverage (Finance) on Wikipedia.