Sales Comparison or Income Approach?

[Stymie]

Hi All,
Real estate agent here. I have a potential single family listing that's in average condition for the area. I have several similar sales nearby that have sold in the $50's and $60's. In my opinion, subject's condition is right in the middle of these comps, and offers from owner occupant buyers will come in right around $60k.

The owner of this particular property is an investor. A tenant was recently obtained and the rent is subsidized @ $1020 per month for two years. (This is an above market rent. Fair market rent is closer to $700.) The owner feels the property is worth closer to $110k -$120k based on the rental income. There are a few sales nearby that support this value, but they have been completely renovated and are far superior in condition and upgrades to the subject property.

Personally, I don't see how you can use the income approach in this particular situation. There are plenty of sales and listings nearby that support a $60k value. If I were an investor buying in this area, I’d buy a similar condition listing and get my own rent subsidized tenant. The return on my investment would be much greater.

My question for you is this – let’s assume we got lucky and found an investor who was willing to buy @ $110k. If you received the appraisal request, would you use the income approach? Could you use the income approach? I was always of the opinion this approach was more appropriate for multi-family dwellings.

Your opinions are appreciated.

Thank you.

 

[Michigan CG]

Let us say that the income approach is required by the lender since the property has a tenant. The appraiser, if they knew what they were doing, would use Market Rent in the income approach thus most likely resulting in your $50-$60,000 value.

The income approach does not always assume the current rent. Just because some idiot is dumb enough to pay over market does not make that market rent because they signed a lease.

 

[Ken B]

The income approach could be applicable. I would need to have a couple questions answered first.

Question 1 - What happens if the current tenant dies tomorrow?

We could go from there, but I suspect it would unnecessary.

 

[DaveH]

Another question to ask is the next buyer going to be an investor or just have the property utilized as a single family home again. Also, with the rents being subsidized market rent is always the best way to evaluate the property for investor reasonings. But, finding a good residential appraiser who understands rental information is not that easy.

 

[J Grant]

what are the current listings priced at ? Are they prices at 110-120k, or 50-70k?

Whether it is sales or income approach, the principle of substitution applies. Ask yourself this, and ask the owner as well...why would a buyer pay 110k for his property, when they could buy a similar home listed for 70k, and pay 65k , and then rent it out?

Appraisers use market rent, not current tenant rent (unless they are equivalent). And rents relates rents to sale prices of similar properties to establish the GRM (gross rental multiplier) , meaning the sales comparison approach is in play no matter what.

 

[Stymie]

Let us say that the income approach is required by the lender since the property has a tenant. The appraiser, if they knew what they were doing, would use Market Rent in the income approach thus most likely resulting in your $50-$60,000 value.

The income approach does not always assume the current rent. Just because some idiot is dumb enough to pay over market does not make that market rent because they signed a lease.

Government subsidized (Section 8) rentals are common in this area and typically range between $800 and $1100 - depending upon condition, number of beds, baths, finished basement, etc. After reading your response, I realized I probably should have originally asked if you can use them or if they're appropriate in developing an income approach.

The income approach could be applicable. I would need to have a couple questions answered first.

Question 1 - What happens if the current tenant dies tomorrow?

We could go from there, but I suspect it would unnecessary.

This is exactly my point of view. Vacant, it's worth $60K. How do you justify another $50k in value just because it's occupied by a Section 8 tenant paying above market rents.

What if the tenant vacates the property or dies tomorrow?

Demand for this area is moderate. There is a high number of competing properties. In my opinion, the above market rent, makes it more attractive to an investor, increases the chances of the property selling and may reduce marketing times, but that's about it.

 

[Michael S]

At most an investor is looking at above market rent for two years. How much are you willing to pay for an extra $320 a month for two years? If I plug in a 10% discount rate I get about $7,000. So a savy investor might be willing to pay a bit more than an owner-user (a bird in the hand is worth two in the bush) but certainly not double.

$700 a month at a sale price of say $60,000 is a gross rent multiplier of about 85. So even if you applied that (incorrectly) to that above-market rent you're only at about $87,000.

 

[Howard Klahr]

In order to receive a meaningful answer you need to provide more details about the rent subsidy. What subsidy program is it? What are the terms and conditions of the subsidy? Is the subsidy tied to the tenant (i.e. portable) or the property? You claim the subsidy is for two years, what happens then?

 

[Restrain]

A lender is going to look at typical properties, whereas the subject is an outlier due to the subsidized rent. A buyer cannot count on always getting a similar rental tenant. That is why market rent and competing similar properties are the determinant factor. A lender is going to look at this the same way as it is looking at a 15-30 year note, not a 2-year time frame.

 

[J Grant]

I am not a section 8 expert, but from what I understand of the program, there is a waiting list to get approved so it's not exactly as if the market is going to be flooded with section 8 tenants lining up for these units. Also, since they can choose where to live as long as it is section 8 approved, wondering why they are paying over 1k a month for a 700 a month unit...maybe in 2 years they will move to rent a larger unit that normally commands 1k a month.

An investor would have to be pretty stupid, aka not well informed, to pay such a high amount for a property just for a short term tenancy where they might not recoup the $. Market value that lenders insist appraisers use references a typically motivated well informed buyer, not the outlier buyer . (the stupid one, in plain terms)