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12/06/2007: "Great News for the Small Multi-Family Marketplace"
Conventional logic says that since many people are losing their homes that the rental market should be better. Thus, the value of small rental properties should increase although the value of single family residential homes are decreasing significantly. Is this proving true? During both 2006 and 2007, although there are peaks and valleys, there is a general reduction in the calculated GAM.
Small rental properties can be very difficult to compare. The interaction between buyer and seller is skewed by the interaction between seller and tenant. The buyer is buying rental income, not so much bricks and mortar. Although the physical attributes plays a part in the sales price, their most significant influence comes from its effect on rental rates, not on buyer preferences.
GAM gives you a number which to compare all small income producing properties regardless of the number of rental units involved. The higher the GAM, the higher the sales price in relationship to the rents, hence the higher the relative value.
One of the best benchmarks for small rental properties is Gross Rent Multiplier (GRM). GRM is the relationship between sales price and monthly or annual rents. For the purposes of this post, I am utilizing annual rents to estimate the Gross Annual Multiplier (GAM). To determine GAM, you simply divide the sales price by the gross annual rents. Very simple.
By tracking GAM, you can determine what is happening in the small income producing property marketplace, but it takes some interpretation.
A word of caution is necessary. There are far fewer small income producing property sales than there are single family residential sales, and the rental amounts are not always readily available. The data from many transactions are sometimes difficult to obtain because the market often operates outside of the realm of real estate professionals, thus MLS does not always show the complete picture, although I am utilizing it for this analysis.
One out-of-whack sale in a limited marketplace can have a significant impact on the results produced, and the Clayton/Fayette/Henry County marketplace is limited. In some months, MLS reported as few as one such sale within the three counties, and in September and October of 2007, there was insufficient information reported with the sales data to estimate GAM. (I carried forward the estimate for August, 2007 for these estimates instead of reporting zero.)
On the two graphs included, the red line indicates calculated GAM. The blue line represents the Linear Regression based on the calculated GAM. In other words, where the market is heading based on the data presented in the red line. 
Why the decline? Many people are being forced into rentals. Very few small income producing properties are being built in the Clayton/Henry/Fayette county market and the population is increasing. Increased demand with low supply should result in higher prices. What's wrong?
Maybe nothing. But, it could be a combination of a number of factors which might include, but is in no way limited to:
Typically, Lenders who finance such properties primarily finance single family residential. Tightening loan underwriting could also be affecting the loans for these type of properties.
Buyers of small residential income properties often are investors in single family residential rentals as well. So, if they are having problems with their single family residential properties they may be forced to liquidate their small multi-family properties as well.
Construction costs are dropping. One contractor I spoke to yesterday reported that construction costs have decreased at least 15% over the past several months. Construction costs have a relationship to market value in that the market will typically not pay more for a property than the cost to replace it.
The news coverage of the "credit crises" may be taking its toll on the emotions of participants in the small multi-family property market. Since houses are down, they may feel that small multi-family properties should also be down.
Two things can cause a reduction in GRM. It can be a reduction in sales price without a corresponding reduction in rents, or it can be an increase in rents without a corresponding increase in sale prices.
If the rental market is improving, then rents must be increasing, resulting in a declining GAM. So, I checked it out. There is not enough rental information on MLS to make a determination as to increases in market rent over a short period of time. Further investigation was required. I asked those who would best know what is happening with rentals, those deal with the leasing and management of small residential properties on a day-to-day basis.
It seems that many property management companies in the south metro area are well pleased with the performance of their small residential properties at the moment. Many are reporting their vacancies are being filled and rents are on the increase. Our own property management division is reaping the benefits of the improving marketplace and our sales division has recently sold a number of such properties.
It is my opinion that the current positive rental market accounts for the decrease in GAM indicated on the graphs.
Gross Rent Multipliers are decreasing because rents are increasing without a corresponding increase in sales prices. That is great news for the small multi-family marketplace. It indicates that once the rental increases are generally recognized by participants in the marketplace, there should be a corresponding jump in values. Should this happen, the smart investor who is buying now will realize a gain, and sellers wishing to sell will reap a windfall.
The Bottom Line: If you are wanting to buy small multi-family properties, NOW is the time to buy, before the increase in rents is generally recognized by market participants. If you are wanting to sell your small multi-family property, you need to start marketing it now! Market it at a price about 15% to 20% over what the current GRM would indicate, and wait for the market to catch up. I feel it will.
If you are interested in buying or selling a duplex, triplex, quad or other income producing property, contact Brande Bradford. She has had great recent success with these properties.
