What Is a Gross Income Multiplier?
A gross income multiplier (GIM) is a rough measure of the value of an investment property that is obtained by dividing the property's sale price by its gross annual rental income. GIM is used in valuing commercial real estates, such as shopping centers and apartment complexes, but is limited in that it does not consider the cost of factors such as utilities, taxes, maintenance, and vacancies. Other, more detailed methods commonly used to value commercial properties include capitalization rate (cap rate) and the discounted cash flow method.
Gross Income Multiplier Explained
The gross income multiplier can be used to roughly determine whether the asking price of a property is a good deal. Multiplying the GIM by the property's gross annual income yields the property's value, or what it should be selling for.
Example of Gross Income Multiplier Calculation
For example, a property under review has an effective gross income of $50,000. A comparable sale is available with an effective income of $56,000 and a selling value of $392,000 (in reality, we’d seek a number of comparable to improve analysis).
Our GIM would be $392,000/$56,000 = 7.
In conclusion, this comparable (or “comp” as is it often called in practice) sold for 7 times (7x) its effective gross. Using this multiplier, we see this property has a capital value of $350,000. Which is found by: V = GIM x EGI, 7 x $50,000 = $350,000.
Drawbacks to Gross Income Multiplier Method
A natural argument against the multiplier method arises because it’s a rather crude valuation technique. Because changes in interest rates (which effect discount rates in the time value of money calculations), sources or revenue (quality), and expenses are not explicitly considered – the gross income multiplier is hardly a practical valuation model, but it does offer a “back of the envelope” starting point.
Other drawbacks include:
- The GIM method assumes uniformity in properties across similar classes. Practitioners know from experience that expense ratios among similar properties often differ as a result of such factors as deferred maintenance, property age and the quality of property manager.
- The GIM estimates value based on gross income and not net operating income (NOI), while a property is purchased based primarily on its net earning power. It is entirely possible that two properties can have the same NOI even though their gross incomes differ significantly. Thus, the GIM method can easily be misused by those who don’t appreciate its limits.
- A GIM fails to account for the remaining economic life of comparable properties. By ignoring remaining economic life, a practitioner can assign equal values to a new property and a 50-year-old property, assuming they generate equal incomes.