Investment Property Information

 

Purchasing real estate for investment can be one of the most challenging decisions that can be made by a corporation, institutional investor, partnership, or individual. Financial and regulatory factors, from finding a property consistent with the prospective owner's investment strategy to financing options and tax considerations, have a profound impact on future profitability.

 

 

Karen Hookstra provides you with the knowledge needed to make sound decisions regarding every critical aspect of the acquisition and ownership of commercial investment property. She thoroughly understands every type of investment real estate-multifamily, office, retail and industrial.

 

What is a cap rate?

 

One of the most difficult and perplexing problems for realtors and investors is finding current Gross and Net Income Multipliers and Cap Rates. Determining the value of an income property generally involves establishing either the Gross or Net Income Multipliers, or the Cap Rate according to comparables.

 

There are a number of difficulties:

 

The Net Operating Income is probably the most widely used indicator of the building's financial performance, and is frequently used in determining the value of the property. The Net Operating Income is the cash remaining after deducting the Operating Expenses from the Effective Gross Income (EGI). There are several items, which often appear on financial statements, which must be deleted before calculating the Net Operating Income (NOI).

 

  1. 1. Debt Service, i.e., principal and interest payments are ignored because the Net Operating Income reflects the earning capacity of the property exclusive of financing. 
  2. 2. Depreciation allowances or any other purely bookkeeping or Income Tax deductions are ignored. 
  3. 3. Capital Expenditures which provides long term benefits such as replacing appliances, painting of the building etc. are omitted.

 

The Capitalization Rate is calculated as follows:


Cap Rate = (Net Operating Income / Market Value) x 100
Cap Rate = (NOI / MV) x 100

 

Example:
Net Operating Income (NOI): $239,430
Market Value (MV): $3,420,000

 

Cap Rate = (239,430 / $3,420,000) x 100
Cap Rate = 7%

 

The Cap Rate of 7% represents the annual return before mortgage payments and income taxes on the total investment of $3,420,000.

 

Alternatively, if the Cap Rate can be established from comparables, we can determine the likely selling price of a property. For example, if the cap rate is 7.5 % based on comparables, and the Net Operating Income (NOI) for the building is $105,000 , the potential selling price can be calculated as follows:

 

MV = (NOI / Cap Rate) x 100
MV = (105,000 / 7.5) x 100
MV = $ 1,400,000

 

The Net Income Multiplier (NIM) is the inverse of the Cap Rate.

 

NIM = 100 / Cap Rate
or Cap Rate = 100 / NIM

 

As an example, if the NIM is 11, the Cap Rate is:

 

Cap Rate = 100 / NIM
Cap Rate = 100 / 11
Cap Rate = 9.09 % B

 

Both the Cap Rate and its counterpart the Net Income Multiplier are used in the real estate industry to estimate the market value of a property. However, in recent times, the Cap Rate has become the more popular financial measure. Regardless of which measure is used; they both produce the same estimate of market value.

 

The Net Income Multiplier is expressed as follows:

 

Net Income Multiplier (NIM) = Market Value / Net Operating Income
i.e. NIM = MV / NOI

 

Example:
Net Operating Income: $239,430
Market Value (MV): $3,420,000
NIM = MV / NOI
NIM = 3,420,000 / 239,430
= 14.28

 

Alternatively, if the Net Income Multiplier can be established from comparables, we can determine the likely selling price of a property. For example, if the Net Income Multiplier is 7.0 based on several comparables, and the Net Operating Income for the building is $180,000 , the potential selling price can be calculated as follows:

 

MV = NOI x NIM
MV = $180,000 x 7
MV = $1,260,000

 

Gross Rent Multiplier

Market rent is the rental income that a property would most likely receive on the open market as indicated by current rentals paid for comparable space. In addition, the appraiser will analyze the sales prices of comparable properties in order to determine the gross rent multiplier (GRM) that represents the relationship between market rent and market value. This ratio is calculated by:

 

Sales Price divided by Gross Rent = GRM

 

The following illustrates how to calculate a monthly gross rent multiplier:

 

Comparable

Sales Price

Monthly Rent

Gross Rent Multiplier

1

$90,000

$750

120.00

2

85,000

690

123.19

3

87,000

715

121.68

4

95,000

800

118.75

5

89,000

730

121.92

Average:

121.11

 

Based upon this analysis, the appraiser can used this estimated GRM and apply it to the projected gross rents of the subject property.  For example, if the appraiser had determined that the market rent for the subject property is $700 per month, the estimated value of the subject property would be:

 

Gross Rent x GRM = Market Value 

 

$700 x 121.11 = $84,777