Apartment buildings are commonly described as “income properties.” Unlike single family homes, apartment buildings (a sub-set of the multi-family property category) are almost exclusively valued based on the amount of income generated on a per-month basis. Appreciation is a factor, but it is not as important when compared to rent collection and the related considerations (i.e. rent control issues, market rents in geographical area, vacancies).
There are two major valuation approaches used when considering the purchase of an apartment building income property: 1) Gross Rent Multiplier (GRM) and 2) Capitalization.
Gross Rent Multiplier (GRM): This approach establishes a number which, multiplied by the gross income of a property, produces an estimate value of the property.
Annual Gross Income MULTIPLIED BY Gross Rent Multiplier = Value
In many cases, an apartment building is listed for a price and the seller discloses the annual gross income and the gross rent multiplier. Most potential buyers have a GRM in mind when shopping for deals. With that GRM figure in mind, they will make offers on apartment buildings of interest.
Capitalization: This approach determines value by considering net income and percentage of reasonable return on the investment (known as “capitalization rate” or “cap rate”). The value of the property is determined by dividing annual net income by the capitalization rate.
Annual Net Income DIVIDED BY Capitalization Rate = Value