GRM vs. Cap Rate

[Alison Swain]

When appraising small income properties (SFR), doesn't it make more sense to use the cap rate as opposed to the GRM? Seems like we're just backing into the GRM and it doesn't really mean anything --- other than doing busy work to make the underwriter happy.

What is your procedure for coming up with a (somewhat) reliable Income Approach that isn't just backed into with your Sales Approach value and the monthly market rent? And what verbiage to you use to justify your methodology?

 

[Michigan CG]

When appraising small income properties (SFR), doesn't it make more sense to use the cap rate as opposed to the GRM? Seems like we're just backing into the GRM and it doesn't really mean anything --- other than doing busy work to make the underwriter happy. Here are some of the problems with using a cap rate for SFR. 1. In order to derive a cap rate you have to determine who pays what and develop a I/E proforma. Now typically the tenant pays everything with the landlord paying RE taxes. Who pays for repairs? Some landlords keep the sewer and water bill in their name. Some duplexes have only one heating system, one water main, etc... Are you going to put a reserve replacement in your I/E? 2. Why do you think it is backing into the sales approach? In valuing income property you should have GRM for all of your comps so you can appraise the property based on those comparable GRMs.

What is your procedure for coming up with a (somewhat) reliable Income Approach that isn't just backed into with your Sales Approach value and the monthly market rent? And what verbiage to you use to justify your methodology?

When appraising an income property it is your job to determine market rent. Then using your derived market rent it is your job to apply the market rent to the GRMs to come up with a market value. It (in my opinion) is the most reliable way to do these types of properties.

PGIM, EGIM, NIM, GRM - these can be used in small income as well as large income properties and are very indicative when good comparables are used.

effective gross income multiplier (EGIM)
The ratio between the sale price (or value) of a property and its effective gross income; a single year's EGI expectancy or an annual average of several years' EGI expectancies (EGIM = V/EGI).

potential gross income multiplier (PGIM)
The ratio between the sale price of a property and its potential gross income (PGIM = V/PGI).

gross profit multiplier
A type of multiplier applied to the gross profit of a recreational vehicle park or other similar operating property to arrive at an indication of its value.

net income multiplier
The relationship between price or value and net operating income expressed as a factor; the reciprocal of the overall rate.

multiplier
A figure that is multiplied by income to produce an estimate of value; called a gross income multiplier when gross income is used, a gross rent multiplier when gross rent is used, and a net income multiplier when net income is used; may be monthly or annual.

 

[Alison Swain]

I guess my problem (confusion) with the GRMs has always been just what data sets are we using anyway? The recent sales comps rarely have rental data --- typically a young family is moving in there to live, not to rent it out. The rental comps haven't sold in years. It seems the only place the formula works is in thoreticals in CE classes. (Maybe it's been too long since I've been in an Income Approach class?! ).

Typically, we're left with a set of Sales Comp data and a separate and distinct set of Rental Comp data ---- and then proceed to back in to the Income Approach. That's what seems wrong to me. Why bother?

Apparently, I'm missing a HUGE link. Guess I just don't do them enough.

 

[Caligirl]

I like using cap rates on small income properties for two reasons:

1. They are understood and frequently used by the buyers and sellers of small income properties in my market; and

2. They 'help' the buyer and the lender make an informed decision about the durability of the cash flow, the risk factors involved in the purchase (ie., market vacancy rates for similar projects), and gives them a good view of true operating expenses.

Having said that, other market participants prefer using GRM in my market for small residential projects. If you are seeing a pattern with GRMs, it is likely an indication that there is a market-based expectation for the relationship between rents and sale price.

 

[Alison Swain]

Having said that, other market participants prefer using GRM in my market for small residential projects. If you are seeing a pattern with GRMs, it is likely an indication that there is a market-based expectation for the relationship between rents and sale price.

Here's the pattern: Samll, 3/1s selling between $110K to $145K, depending on condition. Rents typically around $950.

I'm probably making this harder than it needs to be. How can I develop a GRM for each Rental Comp if it (specifically) hasn't sold recently? Is that even the point? :Eyecrazy: Or is the point to say: okay, houses similar to my subject typicall sell for X; similar houses typically rent for Y --- even if there is no XY overlapping? If not, why are we referring to GRMs (plural).

I'm SO confused!!! :Eyecrazy:


It just seems like anthing I've ever seen done before is basically taking the SA value, dividing by the market rent and putting the result in as the GRM. Viola! SA and IA are magically identical.

 

[Michigan CG]

Alison,

Who says you have to have sale comparables that are rented, or rentals that have sold? If you have three sales of 3/1 SFR residential properties that indicate a value of $110-145 and then you find other comparable properties that are renting for $950 then you now have a GRM range of 116-153.

Doing your homework you find that the rentals in comparison to the solds are at the lower end of the condition range. So now maybe you have a sold range of $110,000-$125,000 or a GRM range of 116-132. From here you must reconcile your data into an opinion of value just like you would if you had comps with cap rates ranging from 8-9.5%.

 

[Alison Swain]

Like I said, I'm making it more complicated than it needs to be. These are not assignments I do on a regular basis and the last time I took a course on the subject was years ago. It did seem like ideal scenarios were always used as examples, which just don't translate to real life.

Given the current climate,I can't wait to get back to continuing ed. Never thought I'd say that!

Thanks for your help!

 

[dane84094]

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

 

[Michigan CG]

Your job as an appraiser is to determine Market Value. In order to do this you have to determine a Market GRM and Market Rent.

Once you have Market Rent then you multiple it with the GRM (multiplier) to determine Market Value.

Your example of selling a property for $40,000 less is not a TYPICALLY motivated seller.

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 Where did you get this GRM....from the subject???not my appraised value. What good is the income approach in this situation?

There is the problem with contracts. Who cares what they are paying for it? it could be $40k over your SCA too, and it wouldn't matter.

If you don't have a contract and have to appraise this thing and do not know what rent the subject is getting you find what Market Rent is and what the market GRM is. If everybody is selling at 120 GRM and market rent is $950 then you have an income approach of $114,000.

If you are deriving your GRM from only a sales contract and the subject rent then you are not appraising. You are number hitting.

If you have 5 sales and they all sell for about 120 GRM and then you have a subject selling for 150 GRM do you see a problem?

If you have a property selling at a 5% cap rate when everything else is selling at an 8% cap rate do you see a problem?

 

[Don Clark]

I had posted this in another thread about a 4 plex. Works for any residential property:


If the question is what rentals to use, then there is a solution. This is a technique I wish I could take credit for but I must give credit where it is due. In a course I took with the AI in 1994 in the Residential Case Study 7 day long course they taught and maybe still teach how to do an income approach by proxy. Find a property similar to the subject that is rented. Then find a property that is similar to the subject that has sold. Then assign the rental of the renta property to the sold property by proxy. Then do what you ordinarily would to find a GMRM . That is, divide the sales price of the closed sale property by the monthly rental amount assigned to it by proxu, and you have a GRM. Do that for as many properties as you can find, then select the appropriate GMRM for the subject. You can find an appropriate rental amount for the subject the same way....by proxy. Be sure and document this in your work file and note what you have done in the appraisal report.

Also, the appraisers job is to attempt to ascertain "Market Rent", not actual rent of the subject. Or, stated another way, what rent the subject should be earning based on what the market indicates for rent.