The income approach and gross rent and gross income multipliers

Income becomes value

The income approach estimates value from a property's expected earning power. It is especially useful for income-producing property such as an apartment building. The principle of anticipation connects expected future benefits to present value. Use supported market rent, vacancy, expenses, and capitalization rates rather than an owner's hopes.

From gross income to net income

Potential gross income is income at full occupancy before vacancy and collection losses. Subtract those losses and add other income, such as parking revenue, to obtain effective gross income. Subtract operating expenses to obtain net operating income, or NOI. Operating expenses include property taxes, insurance, management, and routine maintenance. Mortgage principal and interest, the owner's income taxes, and accounting depreciation are not operating expenses in this calculation. Capital improvements are distinct from routine operating expenses; follow the problem's stated treatment of replacement reserves.

Direct capitalization

Value equals annual NOI divided by the capitalization rate expressed as a decimal. A property with $120,000 in potential annual rent, $6,000 in vacancy and collection losses, $6,000 in other income, and $40,000 in operating expenses has effective gross income of $120,000 and NOI of $80,000. At an 8% capitalization rate, $80,000 divided by 0.08 indicates $1,000,000 in value.

The related formulas are NOI equals value times rate, and rate equals NOI divided by value. With NOI unchanged, a higher capitalization rate produces a lower value. A cap rate is not the property's mortgage interest rate.

Gross multipliers

A gross rent multiplier, or GRM, equals a comparable property's sale price divided by its gross rent for a stated period. Multiply the subject's rent for the same period by that multiplier to estimate value. A $240,000 sale with $2,000 monthly rent yields a monthly GRM of 120. Applying 120 to $2,200 monthly rent indicates $264,000.

A gross income multiplier, or GIM, uses gross income, commonly annual income including additional income sources. A $600,000 sale divided by $75,000 annual gross income yields 8; multiplying a subject's comparable annual gross income of $80,000 by 8 indicates $640,000. Keep the income definition consistent, including whether potential or effective gross income is used.

Gross multipliers do not explicitly deduct operating expenses. Their usefulness depends on comparable properties having similar income and expense patterns. Different expenses can make equal gross incomes produce different net incomes and values.