We recently wrote about direct capitalization, a method to value property via the income approach using the subject’s net operating income and an appropriate capitalization rate. However, this method is typically only used when valuing commercial property or larger apartment properties. Additionally, this method of valuing property can also be challenging when there is not enough credible expense information to estimate net operating income.
In these instances, another method of appraising income property involves gross income multipliers (GIMs) and gross rent multipliers (GRMs). GIMs/GRMs compare the income producing characteristics of properties, most often small residential income properties such as duplexes, triplexes, and four-plexes.
Potential gross income or effective gross income is converted into an opinion of value by applying a relevant gross income multiplier. The multiplier is derived by dividing a comparable property’s sale price by its known gross income or gross rent, either at the time of sale or its projected income over the first year of ownership.
An example of how a gross income multiplier is calculated is shown as follows:
Based on the above, the PGIM (Potential Gross Income Multiplier) of the sales range from 4.35 to 4.44. If the subject has potential gross income of $90,000 and the appraiser applies a 4.40 PGIM, the estimated value conclusion would be $396,000.
An appropriate GIM is derived by utilizing comparable sales. When choosing comparables to derive a multiplier, it is important to ensure the following:
- The comparables used are similar in terms of physical, locational, and investment characteristics (e.g. similar operating expense ratios).
- The comparables used are of properties that were rented at the time of sale or were anticipated to be rented within a short time.
- Gross income or gross rent is identified (gross income may include items other than rent such as laundry or parking income).
- The income and multiplier used are consistent with both the comparables and the subject. In other words, an income multiplier based on effective gross income (EGI) is applied to the subject’s EGI, not the potential gross income.