Why the Income Approach is so Important in Multi-Family Appraisals

While the sales approach often provides a reliable indication of market value for multi-family properties, often focused on a price per apartment unit of comparison basis, appraisers often favor the income approach.  Why?  Because multiple family properties are usually bought and sold by investors who expect a market return on their investment.  Who invests $ 1,000,000 in a 20-unit building and doesn’t expect to receive a market return on their money?  Investment returns in the market change over time and of course for any specific property they are based on risk.

Returns to a multi-family real property are normally considered in the Income Approach based on anticipated net operating income (NOI) and a reasonable, usually market based direct market capitalization rate.  Both of these numbers, NOI and the capitalization rate, can be conclude by an appraiser during the appraisal process with some degree of certainty.

Getting to net operating income requires consideration of who is paying for what.  Some property owners only pay property taxes, common utilities and trash.  While management fees are ignored by many since the properties are self-managed.  An appraiser must impute the cost of management in his analysis.  Reserves are also an expense item that is not often addressed by an owner’s operating income and expense statement but must be considered by an appraiser.  Expense ratios that consider property management and reserves usually fall into a relatively narrow range so it's not difficult for an appraiser to arrive at a net operating income (NOI) that is reasonable.

Appraisers research direct market capitalization rates and it's relatively easy for them to find the low end of the capitalization rate range by investigating rates reported on investment grade properties.  These capitalization rates are always published by large-scale brokerage firms and they generally become a baseline.  

Data on direct market capitalization rates is also made available through offering / listing data.  It takes time to filter through listing and sales data on multi-family properties but the information is out there and it's usually on several Internet websites.  Appraiser files also usually offer a great source of data on capitalization rates although specific information about the source for the data may be confidential and thus it cannot be disclosed in a report.  Appraisers also look at equity yield rates and mortgage yield rates in a "band-of-investment" analysis.  It is another method of discovering an appropriate capitalization rate for a subject property.  

Property’s with established leases are analyzed using yield capitalization which creates a model of pro-forma incomes and expenses that run into the future.  These anticipated returns are discounted using a discounted cash flow analysis using present value factors.  The methodology is usually not applied to multi-family properties since residential leases usually run for only a year leaving a property owner flexible to raise rental rates if the market is moving up.

There is also consideration given by multi-family residential appraiser to actual income versus potential income.  If a multi-family property has a 15.0% vacancy rate but similar properties in the market have a 5.0% vacancy rate, it's important to understand why.  Appraiser ask themselves “is there a physical, functional or economic problem that has created the situation or is it simply poor management?”

Appraisers conclude an income approach value, a sales approach value and when reliable a cost approach value and then they usually reconcile a final point market value opinion.  Since buyers focus on investment returns many multi-family property value opinions are significantly influenced by the income approach.

For more appraisal information contact Glenn J. Rigdon MA, MRICS, ASA is a Las Vegas / Henderson Nevada based appraiser who can be contacted via email or via his business website known as Appraiser Las Vegas  (http://www.appraiserlasvegas.com), or you can also click on “Contact Us” on the home page of this website or visit my public profile at LinkedIn at http://www.linkedin.com/pub/glenn-rigdon-ma-mrics-asa/1a/30b/879/

Article source: http://www.appraisalarticles.com/Multi-Family-Apartment/4598-Why-the-Income-Approach-is-so-Important-in-Multi-Family-Appraisals.html