How to Use the Net Income Multiplier
Want a quick and easy estimate of the value of an apartment or multifamily property? A value you can easily solve using pencil and paper? A value that can tell you what other investors are paying for a property in relation to each dollar spent per Net Operating Income or NOI dollars. How about a value that can be used when comparing similar apartments?
The Net Income Multiplier or NIM can be quickly calculated when you know the Capitalization Rate. For those who enjoy math, NIM or Multiplier is just the reverse or reciprocal of the Cap Rate. The formula is;
NIM = 1 / Capitalization Rate [ Cap Rate = NOI / Market Price ].
Using a little arithmetic you can rearrange the above formula by using the values that make up the Cap Rate. From the formula, we see that the Cap is made up of the operating income and the price of the property. With that in mind, the Multiplier can tell you how many times the Market Price is greater than the NOI. The formula for this relationship is;
NIM = Market Price / NOI.
Rearranging this formula we can arrive for the Price with the following formula;
Market Price = NIM x NOI.
As an exercise let us try some numbers and see what the Multiplier will tell us. An apartment building you are thinking of buying has a market price of $2,500,000. The listing broker has verified that the operating income is $400,000. What Multiplier will you receive?
Multiplier = 2,500,000/400,000 = 6.25
A NIM of 6.25 tells you that the price is 6 1/4 times greater than the income produced by the property. The Multiplier tells you how effective the apartment building is at generating income compared to its market price. Using the Net Income Multiplier in this way gives you some valuable information when you are comparing apartments prior to a purchase.
Can we use the Multiplier to find the Market Price? Another apartment building has a net operating income of $100,000. Similar apartments in the area sell for 11 times their NOI. Using this information, what should be the Market Price of the apartment building in question?
Market Price = NIM x NOI
Price = 11 x 100,000 = $1,100,000
Having the NOI and the prevailing NIMs of comparable properties, will give you an estimate of the market price of a property. You can compare this calculated price against the listed or asking price. Is your market price higher or lower than the asking price? Based on this comparison you can decide if the property is a bargain or too high and not worth your time. If it is a bargain, then you know that further due diligence will be required before making a final decision to buy.
To use these formulas you must verify the values you are given. The Cap, Multiplier or Price must be accurate. Are the values given for the property current with the local values? How where the values generated? Can you recreate these values? These are the questions you must investigate as an investor in order to guide you in your decisions. I like to use a computer analogy, "garbage in, garbage out". Make sure the values you are using are not taken from the garbage.