Valuing Income Producing Properties
(Income Approach)
Income producing properties include apartments, retail properties, office buildings, industrial properties, storage facilities, and mobile home parks. While the numbers are not the same, the basic formula for calculating the value of a property is the same. The formula follows along with definitions:
Scheduled Gross Income of Property $__________________
Less Vacancy Factor $__________________
Equals Effective Gross Income $__________________
Less Operating Expenses $__________________
Equals Net Operating Income $__________________
Apply the Cap Rate (divide) __________________%
Equals the Approximate Value $__________________
Gross Income of Property $1,000,000
Less Vacancy Factor $(50,000)
Equals Effective Gross Income $950,000
Less Operating Expenses $(400,000)
Equals Net Operating Income $500,000
Apply the Cap Rate (divide) 6% (.06)
Equals the Approximate Value $8,333,333
Based on a value of $8,333,333, an investor would earn 6% = $500,000 per year. ($8,333,333 x .06 = $500,000)
Definitions:
Scheduled Gross Income (SGI): This is the amount of income a property will produce assuming it is operating at 100% capacity (no vacancies)
Vacancy Factor (VF): This is generally the actual vacancy or estimated vacancy allowance, whichever is greater.
Effective Gross Income (EGI): The mathematical difference between the SGI and VF
Operating Expenses (OE): This is an estimate based upon industry experience for each type of property. It is usually calculated as a dollar amount per square foot or as a percentage of EGI.
Operating expenses will always include taxes, insurance, maintenance and utilities. It will never include interest on a mortgage.
Net Operating Income (NOI): The mathematical difference between the EGI and OE.
Cap Rate: This number is based on market data (Actual sales of similar properties)
Real estate appraisers and mortgage loan underwriters use this formula.
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