September 9, 2013 – This week’s topic is about Gross Income Multipliers (GIMs) and Operating Expense Ratios (OERs).
Whenever the topic comes up in a seminar I am teaching, I ask the attendees “What is the most important item needed in determining an appropriate GIM?”, assuming the subject and sales are of the same property type. Most of the time no one has an answer or every one is simply shy. Once in awhile, one person will know the answer. Also, in the appraisals we review, about one out of ten reports show the appropriate relationship. The answer – GIMs are inversely related to OERs.
The sale nearest the subject is not necessarily the best GIM indicator. The average of the GIMs certainly is not an appropriate indicator (see a prior post where I contend that the ‘average’ of most anything is not useful in arriving at a value conclusion). A sale of a building similar in age to the subject is not always the best indicator. The best indicator is a sale with the most similar OER to the subject.
I encourage appraisers to include a table showing the sales in sequential order from low to high, or high to low, OER. In an adjacent column you list the GIM that goes with each sale. Lastly, you insert a row for the subject and show its OER. The reader can now conclude with you that the subject’s GIM is somewhere between that of Sales X and Y, which most closely bracket the subject’s OER.
Over the years it dawned on me that this relationship doesn’t just apply within a specific property type (e.g. Office). It also applies across all of the property types (e.g. Apartments, Hotels, Office, etc.).
I took some time this week to research appraisals for GIMs and OERs on a wide variety of property types. Below is what I found in a general range.
Let’s start with nursing home facilities which have among the highest OERs of all property types. I observed GIMs from 1.0 to 2.0 with OERs ranging from 80% to 90%.
Next I looked at hotels – specifically limited service brands. Full service hotels typically have expense ratios above 80% and GIMs also around 2.0 or lower. A large set of limited service hotel sales showed GIMs from 2.7 to 3.6 with OERs from 63% to 74%.
Before we go on, remember these are general ranges. There are always some exceptions, higher or lower. The concept I am showing is that as OERs decline, GIMs increase. That is the most important thought to take away from this discussion.
Apartments have a wide range of OERs. I observed GIMs from 4.5 to 5.5 for OERs around 45%. GIMs ranged from 6.5 to 8.0 for OERs in the 30% to 35% range. One sale had a 24% OER and a 10+ GIM.
My experience is Office building OERs are typically around 33% to 35%. I found some sales with OERs ranging from 30% to 40% and GIMs from 6.0 to 7.0. One sale was on a Triple Net basis and had a 6% OER with a 10+ GIM.
Retail property OERs are often in the 20% to 40% range when reimbursed expenses are included in Potential Gross Income (PGI) or in the sub-10% range if reimbursed expenses are not included in the PGI. The data I observed showed GIMs from 5.4 to 6.3 for OERs from 36% to 43%. GIMs ranged from 7 to 8 for OERs around 20% to 25%. Lastly, GIMs ranged from 9 to 11 for OERs below 5%.
Industrial properties are like Retail properties in that OERs are high for Gross leases and low for Triple Net leases. I observed GIMs from 7.2 to 8.3 for OERs from 18% to 27%. GIMs ranged from 10 to 12 for OERs below 5%.
I would encourage you to take the above data and put it in a table. Appraiser trainees could probably learn a lot from simply seeing how GIMs and OERs change across the property type spectrum.
A question I had 20+ years ago when I started to analyze the above data was why can’t we say that if an OER is 35% the GIM is always 6.5? In my opinion, the most significant reason there is a range of GIMs for any specific OER percentage is a divergence in cap rates (OARs). GIMs, OERs, and OARs are all related by an algebraic formula. As the cap rates decline, the GIMs increase with OERs being held steady.
For 20 years I have thought about making a set of tables where each table has a different cap rate – e.g. 7.0%, 7.5%…10.0%…12.5%. And each table will match up GIMs and OERs for that specific cap rate. Thus, if you were concluding an 8.0% cap rate and a 45% OER, you could go to the 8.0% table and find the appropriate GIM. You could also see how the GIM would change if you lower or raised the cape rate 50 basis points. Maybe one of you reading this will create such tables:)
That is all for this week. A lengthy post, but hopefully you find it of interest.
George R. Mann, CRE, FRICS, MAI