Chapter 14 Ratio Models GIM

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Chapter 14Ratio ModelsGIM Income
Capitalization
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INCOME APPROACH

• TWO BASIC MODELS
• Ratio Models
• Gross Income Multiplier
• Overall Capitalization Rate
• utilize data from sales comps
• Discounted Cash Flow Models
• based on forecasts of expected property cash
  flows
• Discount annual cash flows
• Discount estimated future selling price
  (reversion/residual)

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Gross Income Multiplier (GIM)

• Measures relationship between property gross
  income and sales price
• Can be obtained from comparable sales
• GIMSales Price / EGI
• GIM x EGI Sales Price

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Using PGI or EGI or Gross Rent?

• Doesnt make a big difference
• Be consistent in one or the other MUST use the
  same GI measure for ALL Comps and apply it to the
  same GI for the subject.
• Understand the additional assumptions buried in
  the GIM

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GIMWhat years income to use?

• Since value comes from expectations, better to
  use next years income
• In reality, easier to get current years data

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Sale Price Adjustments

• If necessary, adjust for
• Property Rights
• Financing
• Condition of Sale ??
• Better yet, avoid these sales

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Inflation/Date of Sale Adjustment

• No adjustment, it tends to net out
• Ex. Two year old sale

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Property Size and GIM

• Size affects GIM
• GIM not the same for smaller and larger buildings
• In choosing comparables Match sizes
• Weight the comps in determining the market GIM

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GIM Addl Considerations

• Factors that can affect GIM
• Inflationary Expectations
• Tax Law Changes
• Shifts in Supply/Demand
• Property Type
• Regional Location
• Financing
• If you need to tinker with GIMs, you should
  probably use a different approach

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Is GIM Useful?

• Is GIM too crude?
• If the properties are very similar, GIM is useful
• Many studies show that for apartments, GIM was
  accurate in predicting value

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GIM and Operating Expenses

• GIM only looks at income not NOI
• GIM works best when buildings have similar
  operating expense ratios (OER)
• OER standardized ratio to translate PGI/EGI to
  NOI
• less noise with apartments

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Capitalization Rate (Cap Rate)

• Cap Rate NOI/Sales Price
• Sales price NOI/Cap Rate
• Can be obtained from comps in the market

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Cap Rate Relations

• Cap rate vs. GIM
• Cap ( 1 - OER) / GIM
• Ex. P.272 if OER.35 GIM5.,
• then cap rate .11 or 11 rate of return
• Cap rate vs. Net Income Multiplier (NIM)
• ( 1 / Cap ) NIM
• similar to P / E ratio - not in favor with real
  estate

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Why Cap Rates Differ

• Property A Cap Rate .10
• Property B Cap Rate .15
• Why would someone pay more for the first years
  income in Property A than Property B?

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What affect cap rates?

• Risk of project
• riskier projects higher cap rates
• Expectations of future growth
• higher expectations for future income lower
  cap rates

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Cap rates considerations

• BE CONSISTENT
• Property taxes - should you include property
  taxes when they affect value
• Are Replacement reserves subtracted from NOI
  before calculating the Cap Rate?
• Is the selling price reduced by the first year
  capital expenses (deferred maintenance)
• NOI - Is it current year? Last year? Next (first)
  year after sale? Stabilized (ie. Adjusted for low
  occupancy or other short term effect)

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Cap Rate cont.

• Static income assumption
• Underwriting assumptions - conservative or
  aggressive
• Typically between 8 to 12Sometimes as low as
  6, as high as 15