When Is The Income Approach Used?

[IndyGoldmind]

This is just a general question for the appraisers. From my single-family residential experience, I am familiar with the fact that the sales comparison approach is primarily used to make valuations. I'm trying to research multi-family residential investing now. My question is, for which property types is the income approach almost always used for ? Is it primarily used for ANY multifamily residential property i.e 2-unit dwellings and up or do you start seeing the income approach used with larger multifamily projects? This distinction is very important to me because I think I have seen the sales comparison approach still primarily used even for 2-4 unit dwellings, but am not sure. Any input on this would be helpful.

 

[Lobo Fan]

The income approach can be used for almost any appraisal. It is used when rental income is a factor in the decision. It is more applicable to multi-family but I complete the income approach frequently for single family rental properties.

You want to be sure that your appraiser really documents the market rent and does not just back into the GRM (gross rent multiplier). The GRM can vary wildly from town to town and even neighborhood to neighborhood.

 

[The Warrior Monk]

Theoretically, an income approach can be used for any property that has the potential to be rented. Practically, it should be used whenever the value of the property is in its income stream.

For example, a two-family residence might be owner occupied, which is common. The rent from the other unit can be used to offset carrying costs. Since the property isn't purely an investment property, income stream isn't the primary motive for purchasing the property.

OTOH, a 10-unit property is typically purchased purely for investment purposes; i.e., for its income stream. In such a case, the Income Approach typically is the most appropriate valuation method.

 

[EDWARD BERRY]

You Could Look Around The Neighborhood And Try To Determine What The Prevailing Ownership Is. (owner Occupied And Them Renting The Extra Unit(s) Or Absentee Owners.

If Absentee, And Not Those Who Have Inherited The Property, You Can Usually Say That The Income Approach Is An Important Factor.

 

[PropertyEconomics]

The income approach should be used, and is applicable, when the primary reason for the "investment" is based upon its ability to produce income.

You find fewer residential appraisers using the income approach because frankly many of them dont understand the relationship of value to income production ... I know I will get murdered for saying so ... but that has been my experience.

If income production is the main reason for purchasing then the income is most often the primary method of valuation as supported by the other methods.

 

[hastalavista]

If income production is the main reason for purchasing then the income is most often the primary method of valuation as supported by the other methods.

To tag-on to PE's post...
In most cases, there are two types of buyers:
Onwer-user and Investor.
The owner-user purchases a property for its utility (use) and the investor purchases its property for its income.

As David pointed out, with small residential income properties (2-4 units) there is the potential for owner-user utility. In other words, the typical buyer for a duplex might be purchasing the property to live in and use the 2nd unit's rent to subsidize the mortgage payment. Many times in a case like this, the buyer will pay a premium for certain aspects of the property that an investor would not. That is because the buyer is going to live in the property and certain features (remodeled unit, large patio area, quiet street, etc.) might be of value to an occupant but might not be of significant value to a tenant. A tenant is unlikely to pay a higher rent necessary to offset the cost of a major remodel. An owner-user will pay an additional price for this upgrade since they receive the utility of its use.

Many times, as the number of units increase, the portion of the typical buyer pool for these properties that are owner-user decrease. An owner-user is much more likely to buy a duplex and live in one of the units vs. buying a fourplex and living in one of the units.

If you are strictly an investor, then you should use the income approach to analyze all potential purchase options. But what is important for you to realize is that if you are evaluating a property that also competes for owner-user buyers, then the owner-user may be willing to pay a premium for the property that an investor will not.

There are some markets where duplexes are primarily investor properties (like areas in Sacramento) and there are some markets where many 4-unit properties have an owner-occupant (like San Francisco). All of the advice I've read is good advice. E. Berry suggests that you identify the ownership (owner-occupied or non-owner occupied) of the property-type you are considering to determine how likely the income approach best reflects the motivations of the buyers/sellers. I agree.

 

[IndyGoldmind]

Thank you for the informative replies. I appreciate your time.

 

[Paul Isolda]

In my area many 2 family properties are purchased for owner occupancy of at least 1 of the units. The other unit is sometimes used by a family member or is often rented out to help pay the mortgage. I consider it more appllicable on 3 units and up around here.

 

[TennMan]

If your competing properties in a neighborhood have the potential to rent, as in there is actually rentals available within the area that competes with the subject directly, you should consider the income approach. Most appraisers ignore rental potential.
It does not take that much work to develop a a market rent for a subject based on other rentals in the market. In my area finding rented properties that sell are not difficult to locate. Rentals are becoming more and more common with home ownership shifting because of the market.

 

[tmh1982]

Funny the income on most units these days don't justify the value given the income, vacancy, operating costs, and hopefully if there is anything left maybe some cash flow for the investor taking some risk. Then again, appreciation will pop its head out of the ground..........maybe.........hopefully.........

It is my experience the lower the unit count the less the income approach makes sense. Get in the 100s of units and the income better makes sense or Mr. Lender will not be happy!