Choosing between potential property investments oftentimes poses many challenges, especially for first time investors. Questions regarding whether an investment is worth the capital can be confusing. Having the skill to calculate the gross income multiplier is imperative when choosing between various property investments. While there are other factors that go into making a property purchase, using the gross income multiplier should always be used as a baseline for understanding the rate of investment.
The gross income multiplier is most often relied upon in commercial real estate, particularly when estimating the value of: shopping malls, apartments, condominium complexes. Commercial real estate utilizes this formula to foresee potential profits, income, and expenses.
Gross Income Multiplier Setbacks
Although the gross income multiplier method can be beneficial and rather useful, there are some cons surrounding the use of this method in its entirety. Because the value of property oftentimes varies, changes quickly in periods of low economic growth, inflation, federal rates set by federal reserve, there is a certain level of uncertainty using the gross income multiplier to make business decisions. This lack of consistency requires investors to use caution when relying on this investment calculation as the basis of their property purchases.
Another reason why it is imperative that investors do not use the gross income multiplier formula is the fact that real estate has the ability to appreciate or depreciate in a short period of time. The gross income multiplier method assumes and makes calculations based on properties categorized in the same rank. Critics point out this is a severe flaw revolving around using this specific kind of method when trying to make a precise estimate in respect to a properties value. They go on to argue this method virtually ignores certain details such as the year when the property was built, the overall maintenance upkeep, interest rates, property taxes, etc..
Another critical argument in regards to the gross income multiplier method is that this method makes property value assumptions revolved around gross income and not Net operating income. These flaws would lead some to believe that such a method can be misleading and cause one to make the wrong investment, without having all the listed details involved in the calculations.
How to Use Gross Income Multiplier to Maximize Returns
Skilled investors typically use the gross income multiplier by comparing them to multiple comparable properties. This ensures the investor has the ability to best calculate and understand what the market would be willing to pay for the property.
Example of Gross Income Multiplier
Assume an investor wants to calculate the gross income multiplier of a property they are potentially considering, how would they calculate the gross income multiplier using the example below?
A property is valued at $600,000 and generates $100,000 in overall yearly revenue. To calculate the gross income multiplier, the investor needs to simply divide $600,000 by the $100,000 yearly income and they would derive at the answer which is 6.