Definition of gross income multiplier

What is a gross income multiplier?

A gross income multiplier (GIM) is a rough measure of the value of an investment property. It is calculated by dividing the selling price of the property by its gross annual rental income. Investors can use the GIM, along with other methods such as the capitalization rate (capitalization rate) and discounted cash flow method, to value commercial real estate such as shopping malls and apartment complexes. .

Understanding the gross income multiplier

The valuation of an investment property is important for any investor before signing the real estate contract. But unlike other investments, like stocks, there is no easy way to do it. Many professional real estate investors believe that the income generated by a property is much more important than its appreciation.

The gross income multiplier is a measure widely used in the real estate industry. It can be used by investors and real estate professionals to roughly determine whether the asking price of a property is a good deal, just as the price-to-earnings (P / E) ratio can be used to value companies on the market. stock Exchange.

By multiplying the GIM by the gross annual income of the property, we get the value of the property or the price at which it is to be sold. A low gross income multiplier means that a property may be a more attractive investment because the gross income it generates is much higher than its market value.

Special considerations

A gross income multiplier is a good general real estate metric. But there are limits because it doesn’t take into account various factors including the costs of running a property including utilities, taxes, maintenance, and vacant housing. For the same reason, investors should not use the GIM as a means of comparing one potential investment property to another, similar. In order to make a more accurate comparison between two or more properties, investors should use the Net Income Multiplier (NIM). The NIM takes into account both the income and operating expenses of each property.

Disadvantages of the gross income multiplier method

The GIM is a great starting point for investors to assess potential real estate investments. This is because it is easy to calculate and provides a rough picture of what buying property can mean to a buyer. The gross income multiplier is hardly a practical valuation model, but it does offer a starting point at the back of the envelope. But, as mentioned above, there are limitations and several key drawbacks to consider when using this figure as a means of valuing investment property.

A natural argument against the multiplier method arises because it is a rather crude valuation technique. Because changes in interest rates, which affect discount rates in calculations of the time value of money, sources, income and expenditure are not explicitly taken into account.

Other disadvantages include:

• The GIM method assumes uniformity of properties between similar classes. Practitioners know from experience that expense ratios between similar properties often differ due to factors such as deferred maintenance, the age of the property, and the quality of the property manager.
• GIM estimates value based on gross income and not net operating income (NOI), while a property is purchased primarily based on its net earning capacity. It is quite possible that two properties could have the same NOI even if their gross income differs considerably. Thus, the GIM method can easily be misused by those who do not appreciate its limitations.
• A GIM does not take into account the remaining economic life of comparable properties. By ignoring the remaining economic life, a practitioner can assign equal values ​​to a new property and a 50 year old property, assuming they generate equal income.

Example of gross income multiplier calculation

A property under study has an effective gross income of $ 50,000. A comparable sale is available with an effective income of $ 56,000 and a sale value of $ 392,000 (in reality we would look for a number of comparables to improve the analysis).

Our GIM would be $ 392,000 ÷ $ 56,000 = 7.

This comparable – or comp as it is often called in practice – sold seven times (7x) its actual gross. Using this multiplier, we see that this property has a capital value of $ 350,000. This is found using the following formula:

V = GIM x EGI

7 x $ 50,000 = $ 350,000.