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