What is Gross Income Multiplier?
Gross Income Multiplier is used to appraise the value of the property like commercial real estate, apartments for rent, shopping center, etc. and is calculated as the ratio of the Current Value of the investment/property to its gross annual income earned.
Gross Income Multiplier Formula
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For eg:
Source: Gross Income Multiplier (wallstreetmojo.com)
Hence, the gross income multiplier is the ratio of the current value and annualized income of a property or an investment that is required to be sold off.
- Current Value of the Property – It is the current market price of the property. The owner can either determine thus value on his own by taking the current market and expectations of people, its location factor, etc. into consideration. On the other hand, the owner can also take the price from any other property taking the sales history or rental income of a competitive property into consideration.
- Gross Income of the Property – Gross income of the property includes the average annual rent of the apartments or building held for rentals, the Average annual turnoverAnnual TurnoverAnnual turnover is the yearly sales or yearly receipts of a profession. In finance, the annual turnover is commonly referred to by mutual funds and exchange-traded funds (ETF), measuring its annual investment holdings that determine the health and activity levels of the fund.read more of the products held for the trading purpose for manufacturing purpose, etc. Thus it is merely the Income earned or expected to be earned from the property for which the deal is being finalized.
Thus it can be said as it is the Fair Market Value of the property.
Example of Gross Income Multiplier
Suppose Mr. X has a house property in a specific location. As per the market conditions and according to similar properties in the neighboring location, the current value of the property is $7 million. Further, it was rented out by him to its tenants, which generated an annualized rental income if $1 million. Calculate the gross income multiplier of the house property of Mr. X.
Solution
Calculation of Gross Income Multiplier
- = $7 million / $1 million
- = 7 times
Advantages
Following are various advantages which include the following:
- Because of the simplicity in the calculation of gross income multiplier, it has gained a lot of academic attention. At the same time, it is also used practically to determine whether a particular property is receiving a good deal.
- It can be related to stock valuation since the ratio of this multiplier is the current value of the property divided by the net operating incomeNet Operating IncomeNet Operating Income (NOI) is a measure of profitability representing the amount earned from its core operations by deducting operating expenses from operating revenue. It excludes non-operating costs such as loss on sale of a capital asset, interest, tax expenses.read more of the property can be very well connected with the traditional price/earnings ratio. Hence it is based upon commonly used concepts.
- The concept of gross income multiplier is neither old nor much newer concept since it is being used in property and real estate valuation for decades, nor has it gained a lot of usefulness by so many owners and individuals and is used in their day-to-day valuation over the period.
- It is very well relative to the current market, and demand-supply conditions since the calculation make it clear that with the rise in the value of the property in the market, the gross income multiplier increases, while with a reduction in the annualized rate of returnThe Annualized Rate Of ReturnThe annualized rate of return is the percentage of return an investment provides yearly. It serves as a basis for comparison when the rate of return on short-term investments (i.e., the ones made for less than a year) are annualized.read more or income from the property gross income multiplier tends to decrease.
- Since GIM doesn’t take into consideration is operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more, it is straightforward to calculate the gross income multiplier of a property that is already sold out against any other methods like Capitalization rateCapitalization RateCapitalization Rate is the rate that helps determining value of a real estate investment. It projects the expected rate of return on the investment made. read more.
Disadvantages
The different limitations and drawbacks include the following:
- One of the most significant disadvantages of gross income multiplier is that it does not take into consideration expenses and other related costs into account while calculating the income multiplier. Hence costs like license, cost of utilization, maintenance taxes, etc.
- The vacancy is not taken into consideration under GIM, which is an essential part of a house property. Thus final multiplier answer may be irrelevant.
- It can only be used for comparison purposes with other property; thus, it is a very strong concept in relative terms, and however, it doesn’t gain much importance in Absolute terms.
- This concept is usually used in real estate properties, rental properties, and investments; however, in other fields like buildings, etc. it does not gain much of the importance.
Important Points
- It is essential to take note that the concept of gross income multiplier has been in use since the era where real estate property is being sold. Hence it has been used since the year 1740 when Thomas Miles showed income multiplier variations.
- Richard Radcliff states that if the concept of GIM is used properly, it can also be used in determining the market value of the property by filling up details in the formula and taking the current market value of the property variable.
- It is a market-derived concept and hence gains many meanings as it is a market-derived concept that doesn’t change with personal judgments as it is an objective concept as against other subjective concepts.
Conclusion
To determine whether a property is sold at a good deal and as per its current market conditions depending upon its annualized income, the Gross income multiplier can be easily applied by anybody without incurring much cost and spending more time. Hence common use and easy application of this concept is a beneficial concept.
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This article has been a guide to Gross Income Multiplier. Here we discuss the formula to calculate gross income multiplier along with a practical example, advantages & disadvantages. You may learn more about accounting from the following articles –
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