GRM vs. Cap Rate

[ZZGAMAZZ]

Wouldn't a multi-unit residential income property investor want to know how much a property would be worth in the future rather than today?

I received some very valuable insight when I asked a similar question before, but I'm still wondering if there is a potential market for prospective residential appraisals?

 

[PropertyEconomics]

Allison,

I am just as baffeled why we use the GRM.
I have a question for Tim. If a buyer has a contract from a motivated seller for $40k less than my "sales comparison approach" value. the GRM supports the lesser value not my appraised value. What good is the income approach in this situation?

Dane

Gross Rent Multipliers are used because they are much easier to determine within this segment of the market. Unless you have very thorough expense data provided to you by the property owner(s) of both the subject and all the comparables it is impossible to develop a cap rate.
I typically see GRM analysis done in properties of 6 units or less and cap of income in properties of 10 units or more with the inbetween number of units going either way.
Im not sure I understand why GRM methods are "backing into" the market approach. If you dont have adequate income and expense data the cap method would be even more suspect to error.

 

[PropertyEconomics]

Wouldn't a multi-unit residential income property investor want to know how much a property would be worth in the future rather than today?

I received some very valuable insight when I asked a similar question before, but I'm still wondering if there is a potential market for prospective residential appraisals?

And what does your crystal ball tell you investment properties will be worth 16 months and 21 days from today??

 

[Michigan CG]

Wouldn't a multi-unit residential income property investor want to know how much a property would be worth in the future rather than today?

And what does your crystal ball tell you investment properties will be worth 16 months and 21 days from today??

Well if it is a typical new investor it will be worth less because they won't spend money to maintain it, rents will go down, tenant quality goes down, owner sells it. New guy throws money at it and flips it. New owner doesn't spend money to maintain it...............

 

[ZZGAMAZZ]

Well, there would certainly be a large measure of forecasting required.

From what I understand, nobody can predict the future regardless of the sophistication of the statistical model . . . kinda like a perfect r square correlation means squat in terms of tomorrow rather than today.

However, each residential collaterization involves hundreds of thousands of dollars of risk; and it seems logical that an investor would want to know the future value--possibly in increments of 1, or maybe 5 years--more so than today's value, which per the principle of change is fleeting.

Whoever wrote SMT-4 must have envisioned practical application of prospective opinions, and it goes so far as to describe tangible issues such as "the overall economic climate" and "variations in the business cycle."

For example, the current residential crisis could be described more correctly as a formal correction or as regression to the mean; and most all of "us" knew a year ago that the freefall was inevitable, despite that I've got the advantage of hindsight to make this observation.

Somebody, somewhere with knowledge of appraisal and of mathmatics should be able to develop an "approach" that would be extremely valuable to potential investors, especially as regards to the recent failure of so many lenders who's decisions were based upon the effective date rather than a prospective date.

The approach would be based upon a model that would require an appraiser to enter data concerning the subject, its relation to its environment, the economic climate, etc., etc. The results would be largely automated yet based upon the knowledge of real estate markets available only to a knowledgable appraiser.

I'm attending a course on propspective appraisals tomorrow and will keep everybody updated...

 

[Fred]

Somebody, somewhere with knowledge of appraisal and of mathmatics should be able to develop an "approach" that would be extremely valuable to potential investors, especially as regards to the recent failure of so many lenders who's decisions were based upon the effective date rather than a prospective date.

Those who make the regulations for how banks invest taxpayer guaranteed money in real estate have made a long standing decision on how to use valuations - the amount of the loan divided by the current value at the time the loan is made. They could be base loans on three-year propsective REO-value. But they don't.

 

[Mr Rex]

Not to hijack the thread, but while Steven is paying attention I thought I would throw this in. I have often thought that the lenders would be interested in a model that quantified and perhaps projected supply and demand in individual market areas. Currently this is based on dated census data etc. Saw an article in the local/regional paper that Progress Energy (who acquired Florida Power and Light a few years back) had pre bubble deflation identified 80k homes in FL as 2nd homes based on sporadic energy usage. They currently have identified another 30k in FL that they suspect were purchased by speculators and are on the way to foreclosure based on electrical usage. Maybe yet another way to build the model to determine the true market level of absorption etc. Im just saying, there is a better way to track speculation vs true market demand/supply, and this might be one.

 

[PropertyEconomics]

Not to hijack the thread, but while Steven is paying attention I thought I would throw this in. I have often thought that the lenders would be interested in a model that quantified and perhaps projected supply and demand in individual market areas. Currently this is based on dated census data etc. Saw an article in the local/regional paper that Progress Energy (who acquired Florida Power and Light a few years back) had pre bubble deflation identified 80k homes in FL as 2nd homes based on sporadic energy usage. They currently have identified another 30k in FL that they suspect were purchased by speculators and are on the way to foreclosure based on electrical usage. Maybe yet another way to build the model to determine the true market level of absorption etc. Im just saying, there is a better way to track speculation vs true market demand/supply, and this might be one.

Quite an interesting observation Mr Rex ... Interesting in deed. Comparision of those statistics with those which are actually foreclosed or short sold among those homes would be a very interesting statistic to find. Perhaps then forecast of foreclosures against sporadic energy use could be made ... thus providing some indication as to market trends both in pricing and absorption.
I for one am not a fan of forecasting as each market cycle is quite different and the statistical probablity of being right over a long period of time would be low I would believe. Shorter forecasting may be more reliable .. and while we all saw the downturn coming ... I dont think any one could have anticipated (without a tremendous amount of information which was simply not available) the downturn in the credit markets, the increase in oil prices, and the overall true inflation which also hurts the residential home market. Might be an interesting study for an advance college course though.

 

[Lost Cause]

Not So Unusual

Wouldn't a multi-unit residential income property investor want to know how much a property would be worth in the future rather than today?

I am a little surprised to see this question asked as if this isn't done all the time. Valuations for proposed development are routinely done on a prospective basis (though some are valued on a hypothetical as-if-completed-today basis). Often times both developers and potential lenders will work up DCF projections of proposed developments or investments and use the projection to gauge likely future cash flows. Investors will generally set up DCF projections with several sets of assumptions delineating the best-case to worst-case scenarios. So, yes GAMA, they would want to know that, and many do.

And what does your crystal ball tell you investment properties will be worth 16 months and 21 days from today??

While PE's rhetoical question implies it's silly by being so precise in the time period, those investors doing DCF analysis of proposed projects can tell you what they think it will be worth at some point in the future. Those doing a full spectrum of scenarios can tell you what it will be worth if this happens and what it will be worth if that happens.

And appraisers should never consult their own crystal balls, they should be evesdropping on investor's crystal balls. An appraiser's job is never to predict the future, but rather to reflect market participants' expectations about the future.

 

[Fred]

I am a little surprised to see this question asked as if this isn't done all the time. Valuations for proposed development are routinely done on a prospective basis (though some are valued on a hypothetical as-if-completed-today basis). Often times both developers and potential lenders will work up DCF projections of proposed developments or investments and use the projection to gauge likely future cash flows. Investors will generally set up DCF projections

True, but the original question was about houses, and this type of investment analysis isn't done there. Also, the use of cash flow forecasts (DCF) tends to reduce the need for future values. After all, from a lender's risk point of view, as long as the cash flow is greater than the mortgage payment, the exact value of the collateral at any particular moment may become a secondary consideration.