The Gross Income Multiplier indicates how many times the price/value of the property is greater than the gross income it delivers to its owner. However, because there are two concepts of gross income in the real estate industry, the Potential Gross Income (PGI) and the Effective Gross Income (EGI), there are also two respective multipliers that involve a property’s gross income: the Potential Gross Income Multiplier (PGIM), and the Effective Gross Income Multiplier (EGIM).
Potential Gross Income Multiplier
The formula for calculating the Potential Gross Income Multiplier (PGIM) is:
PGIM = Market Price / Potential Gross Income
It is more meaningful to calculate the PGIM on an annual basis and thus the annual Potential Gross Income (PGI) is typically used in the above formula. The Potential Gross Income Multiplier indicates how many times the price/value of the property is greater than the potential gross income that it generates and is calculated using the following formula:
Potential Gross Income (PGI) = Potential Gross Rental Income (PGRI) + Other Income
PGRI = Net Leasable Area * Market Rent (per sq. ft.)
or PGRI = No. of Units * Market Rent (per unit)
Notice that the Potential Gross Income includes primarily rental income, but it accounts also for any other income that may be produced by the property, such as income from vending machines, laundry room, parking, etc. To better understand how the PGIM is calculated, consider the following example:
Number of Units = 10
Market Rent Estimate (Annual) = $12,500
Other Income (Annual) = $5,000
Market Price = $1,000,000
Potential Gross Income = 10 *12,500 + 5,000 = 130,000
Potential Gross Income Multiplier = 1,000,000/130,000 =7.69
Thus, in this example, the PGIM is 7.96, indicating that the asking price is 7.69 times greater than the potential gross income produced by the property.
Effective Gross Income Multiplier
As discussed earlier, the second concept of gross income that property investors need to be aware of is the Effective Gross Income (EGI), which is calculated using the following formula:
EGI = Potential Gross Income (PGI) – Vacancy & Bad Debt Allowance
The new elements in the above formula include the vacancy and bad debt allowance. The vacancy allowance accounts for space/units that remain vacant during the year and, as such, do not actually provide any rental income to the landlord. The bad debt allowance represents rental income that is owed during the year, but is not paid by the tenants. Once we have an estimate of the EGI of the property, we can use the following formula to calculate the Effective Gross Income Multiplier (EGIM):
EGIM = Market Price / Effective Gross Income
In order to better understand how the EGIM of a property investment can be calculated consider the following example:
Potential Gross Rental Income = $125,000
Vacancy and Bad Debt Allowance (8%) = $10,000
Other Income = $5,000
Market Price = $1,000,000
Effective Gross Income = 125,000 + 5,000 – 10,000 = 120,000
Effective Gross Income Multiplier = 1,000,000/120,000 =8.33
Thus, in this example, the asking price is 8.33 times greater than the effective gross income produced by the property. Since the effective gross income of a property is lower than the potential gross income the EGIM should be higher than the PGIM, as is the case in our example.
How the gross income multiplier concept can be useful to an investor? Well, in my opinion is not very useful because is based on gross income and not Net Operating Income (NOI), which takes into account also operating expenses, measuring in this way the net income that goes into the investor’s pocket. A net income multiplier (calculated as market price over NOI) would be a more useful metric since it would provide an indication of the payback period of the investment, under the assumption that it remains constant through time. A net income multiplier is actually the inverse of the going-in cap rate or initial yield, which is equal to NOI over market price. The net income multiplier, although more useful than the gross income multiplier, it is still an incomplete measure of property investment performance. A more thorough and complete evaluation of the performance of a property investment can be carried out with the use of the discounted cash flow model and the calculation of the internal rate of return (IRR) of the property under consideration.
Kolbe, P. T., & Greer, G. E. (Author), Gaylon E. Greer. (2012). Investment Analysis for Real Estate Decisions, 8th Edition. Dearborn Real Estate Education.
Geltner, M., Miller, N. G., Clayton, J., & Eichholtz, P. (2013). Commercial Real Estate Analysis and Investments (with CD-ROM). Oncource Learning
Clauretie, T. M., & Sirmans, G.S. (2009). Real Estate Finance: Theory and Practice 6th Edition. Oncource Learning.
Net Operating Income (NOI)
Internal Rate of Return (IRR) and Property Investment
Property Investment Basics: Before-Tax Cash Flow
High-Return Property Investing
Exit Cap Rate: A Key Figure in Estimating or … Misestimating the Resale Price
Property Investment Analysis: The Discounted Cash Flow Model
Property Investment Basics: Real Estate Return Measures