SMALL RESIDENTIAL INCOME PROPERTY
What is a Small Residential Income Property
We all know that a small residential income property has two, three or four units. However, in some areas of the country small residential income properties can be found as part of a condominium project. In other parts of the country, one or more of the units could be a manufactured home. For those of you in areas where these are found, it is important to know that you should use the small residential income property appraisal report (SRIPAR) for these types of small income properties. In addition, if the subject is part of a condominium development, also complete the Condominium Project Information section of the individual condominium unit appraisal report. If one or more of the units is a manufactured home, also complete the HUD Data Plate and Improvements sections of the manufactured home form.
IMPROVEMENTS
In your development of the square footage of the subject for a small income property appraisal assignment, you develop both a Gross Living Area (GLA) and a Gross Building Area (GBA). These are two different measures.
The first, gross living area, is based on the square footage calculated by including the exterior perimeter walls of each unit. It is recognized that you may need to estimate the thickness of the walls. The GLA does not include attic, basement or other areas assigned to the unit. GLA is computed for two- to four-unit properties in the same way it is computed for a single family property.
FHA specifically advises, “The gross living area is obtained by drawing an imaginary line on the outside perimeter walls of each unit (similar to the method used to measure a single family dwelling).”
The concept of gross building area is not typically applied in single family or condominium appraisal assignments. GBA is the total finished area of the building or buildings, including hallways, interior stairways and common areas regardless if the area is above and below grade. The measurements are based on the exterior of the subject. All the finished area is lumped together. FHA specifies, “Use same method for calculating GBA of comparable sales.”
The unit of comparison which is supposed to be developed in the sales comparison for analysis purposes is Sales Price per Gross Building Area. The problem for appraisers is the data for comparison purposes may not be based on gross building area. That is, many area reporting services do not provide the GBA for the sales, but rather routinely report only the GLA as it is defined here or some approximation.
You may be forced, with proper disclosure, to use a price per GLA in the unit of comparison analysis of the sales comparison as you are not able to develop a reliable GBA for the comparable properties. If you are not able to develop a reliable GBA for the comparables, it follows you will not be able to develop a reliable price per GBA.
Be sure to develop both estimates (GLA and GBA) of the subject as you are required to by the assignment. Then, if your price per GBA analysis would not be reliable as your data sources report only GLA, disclose in the analysis summary you are using GLA as the basis of the comparison and why.
The key issue is consistency. For the unit of comparison analysis, be sure the unit of comparison for the subject is developed on the same basis as the units for the comparables. If you are not consistent in this way, you are comparing the proverbial apples to oranges. If you are not consistent, your result from the unit of comparison analysis based on price per square foot will be skewed in one direction or another.
COMPARABLE RENTAL DATA
The instructions at the start of this section of the SRIPAR read: “This analysis is intended to support the opinion of the market rent for the subject property.” No doubt that is true. Perhaps this statement would be better if it read, “This analysis is intended to develop a market rent estimate for the subject property.” By definition, if the analysis is properly completed, the result will be a properly supported opinion of the market rent estimate for the subject. There are three elements in the development of the market rent estimate. These are the rent survey, the lease or rent analysis of the subject, and the application of the results.
In the rent survey phase of the market rent estimation, you are attempting to find properties which are as similar to the subject as possible and confirming what their contract rents are, including the terms of the lease or rental agreement. The rental comparables may or may not be the same as the properties used in the sales comparison analysis. They often are different, because rental data may be more widely available.
By the processes of researching current contract rents of the rent comparables, the appraiser is then able to form an opinion of what the subject should rent for in the market. In a very real way, it is the application of the appraiser’s judgment which transforms researched contract rent data into a market rent estimate for the subject.
It is not appropriate to estimate “market rents” for rental comparables which are vacant or which the appraiser believes are rented at some rate other than market rent. If rent comparable units are vacant, they are simply not rent comparables. What they are offered for in the market is certainly a data point. What they were rented for prior to vacancy may be a good reflection of market rent and may be considered.
Similarly if you think a rent comparable is rented below the market, do not try to show it at what you judged it should rent for. All that does is weaken the credibility of your analysis, and it represents putting the cart before the horse in your analysis.
Be sure to analyze what is included in the rent of the rent comparables; water, sewer and garbage, among others. Be sure you form your opinion of the estimate of the market rent for the subject on the same basis, including the same elements.
In the rental contract analysis for the subject, be sure to identify what is included in the contract rent for the subject. The subject’s contract rent may be below, equal to, or above the rents you find in the marketplace.
Ideally the properties you use to develop the market rent estimate for the subject will be different properties than those used in the sales comparison. Finally, don’t forget the power of unit of comparison analysis in the development of a market rent opinion. Unit of comparison analysis could include rent per GLA or GBA and rent per bedroom. There may be other meaningful units of comparison of which you are aware in your local area.
Be sure to summarize the adequacy of the comparable rentals and address any rental concessions which are included in your market rent estimates. As an example, it is well known in many markets that there is a tradeoff between amount of the contract rent which can be charged and the amount of the security deposits and such. The lower the security deposits, etc., the greater the rent a landlord will be able to charge.
SALES COMPARISON APPROACH
In a perfect world, where the subject is a tri-plex, the appraiser would be able to readily research and employ three comparable tri-plexes. FHA recognizes the world is not perfect. FHA advises it is acceptable to mix properties with a differing number of units for comparison. For example, it is acceptable to use a 3-unit property as a comparable for a 4-unit, or a 2-unit property as a comparable for a 4-unit property.
If you are forced to use a range of sales, then for purposes of estimating comparables available for sale and which have sold, open up your analysis to include those unit types.
There may be great properties to use in the sales comparison which are not rented at the time of their sale. Resist the temptation to estimate market rents for comparables which were vacant at the time of sale, or for units which were above or below the prevailing market. Estimating a market rent for vacant units or for those which are thought to be rented below the market significantly reduces the credibility of the analysis. Such techniques may so limit the credibility of the analysis as to render it no longer credible.
The protocol instructs you to “Enter the Gross Monthly Rent for the subject property and each comparable sale.” This is used to calculate the gross rent multiplier (GRM) of the sale. If you ignore current contract rents, vacancies, and below or above market rents of the sales and impute or provide your own estimate of the market rent, you are not reflecting the actual market data from the sale. By injecting your opinion of what the rent should have been for the comparable in such a way, you’re pulling more “information” (GRM) from the sale than the sale can really provide you.
Remember, you can always use different sales than those from the sales comparison analysis to develop a GRM.
FHA further suggests – and I think all appraisers would agree – that you should avoid minor adjustments in your sales comparison which probably do not reflect the market. Also, not all dissimilarities result in market reactions. There may be differences between comparables and a subject which are just that, differences, but the market is indifferent to the differences. FHA specifies adjustments must be “extracted from and supported by the actions in the market.”
For example, there may be certain adjustments you use in the single family world which you may, without much thought, apply in your two to four family assignments. It can be true that differences in square footage between small income properties may not be as meaningful. Rents may be fairly uniform over some range of square footages in your market area. As a result, carrying over adjustments typically used in single family assignments may result in a sales comparison which does not properly reflect the influences on value found in the small residential income property market.
In the course of completing the sales comparison analysis, you will develop a fairly thorough unit of comparison analysis. You will develop a value indication for the subject based on a reconciled price per room, price per unit, price per GBA and price per bedroom. This, in addition to your unadjusted price per property and adjusted indicators, should provide strong indications as to the subject property’s value.
Of course, value indicators are rarely, if ever, totally consistent. For this reason, you reconcile. FHA advises to summarize the sales comparison, including reconciliation of indications of value from unit of comparison analysis. While averaging, especially weighted averaging, has been gaining favor as a reconciliation technique over the years, remember averaging is just one technique or tool in your toolbox. On the list of reconciliation techniques, it is near the bottom. It should be used sparingly. FHA advises you not to average to account for differences in the indications of value.
INCOME
The income approach, Gross Rent Multiplier (GRM) analysis, requires your thoughtful preparation. This seminar is not about how to develop a GRM analysis. It is assumed you know the mechanics of it. FHA’s direction here is to provide a reconciliation of the multipliers. “Judge comparability and applicability of each. Do not average, account for differences.” Sound familiar?
Provided here is the link to the Reference Guide for Gross Rent Multiplier analysis. As of this writing, it was a bit dated, as it refers to the separate GRM form which was allowed by FHA. Your 2 to 4 unit properties are to be completed on the SRIPAR form, so you no longer could or would use a separate GRM form. This link takes you to additional areas of interest for the appraiser completing a 2 to 4 unit property appraisal for FHA.
http://www.hud.gov/offices/hsg/sfh/ref/sfhp1-03.cfm
COST APPROACH
The cost approach is generally not required. It can be used if you complete it by choice. It must be completed if it is necessary for credible assignment results or you agree with your client to complete the cost approach. The cost approach is required if the subject is a specialized property or a manufactured house.
Even though you do not complete a cost approach, you must provide an estimate of remaining economic life of the subject. The estimate may be a single number or a range. Don’t forget the magic 30 years. If your estimate of the remaining economic life is less than 30 years, provide an explanation.
FHA advises, “The gross living area” is obtained by drawing an imaginary line on the outside perimeter walls of each unit.”
