Real Estate Financing and Investing/How To Value an Income Producing Property

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There are several rule of thumb methods to arrive at the estimated value of an income producing property. They include:

  • Gross Income Multiplier. Gross income multiplier is calculated as:

Purchase price / gross rental income

Example
In Mr. Smith`s example from the previous chapter, the gross income multiplier is:

$219,000 / $23,600 = 9.28

A duplex in the similar neighborhood may be valued at "8 times annual gross." Thus, if its annual gross rental income amounts to $23,600, the value would be taken as $188,800 (8 x $23,600). Warning: This approach should be used with caution. Different properties have different operating expenses which must be taken into account in determining the value of a property.

  • Net Income Multiplier. Net income multiplier is calculated as: Purchase price/net operating income (NOI)

In Mr. Smith`s example, the net income multiplier is:

$219,000 / $18,618 = 11.76

  • Capitalization rate. Capitalization rate is almost the same as the net income multiplier, only used more often. It is the reciprocal of the net income multiplier. That is:

Net operating income (NOI) / purchase price

Example
Let us go back to Mr. Smith`s example. The duplex`s capitalization rate is $18,618 / $219,000 = 8.5%. Whether it is over priced or not depends on the rate of the similar type property derived from the market place. Suppose the market rate is 10%. That means the fair market value of the similar duplex is $18,618 / 10% = $186,180. Mr. Smith may be overpaying for this property.