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Appraisers use three different methods to estimate the value of real
estate. They are the income approach, the sales comparison
approach and the cost approach. The sales comparison approach
is considered the best method for appraising single family homes.
The cost approach is used to appraise special purpose buildings
such as churches, schools and public buildings. The income
approach is used to estimate the market value of income producing
properties such as office buildings, warehouses, apartment buildings
and shopping centers. When adequate financial data for recent
sales of similar income producing properties is unavailable,
appraisers may utilize all three approaches. The following is a
brief and simplified summary of the income approach. The
income approach is used when reliable financial data is available
for recent sales of similar income properties in a given market
place. A property's net operating income and sales price are
used to calculate a capitalization rate for the sale of each similar
property in a given area or market place. If sufficient sales
of similar income properties are available, a market cap rate can be
determined by averaging the cap rate values from the individual
sales. Appraisers will sometimes use a market gross rent
multiplier or gross income multiplier instead of a cap rate to
estimate the value of single-family rentals and 2 units.
Income
Approach Summary - Net operating income is calculated like this.
1) The appraiser first estimates the annual potential gross
income for a property. This involves estimating how much rent
each unit could generate in the current market place. The
rental rates being charged by the current owner may be too low and
may not reflect potential market rental rates. Appraisers
study the current market place to estimate potential rental
rates.
2) The appraiser then calculates an effective gross
income for the property by reducing the annual potential gross
income by a vacancy allowance amount. The vacancy allowance
amount is determined by current market rental conditions for the
type of property being analyzed.
3) Miscellaneous income such as parking fees, laundry and
vending receipts are added to the income.
4) Operating expenses are deducted from the effective gross
income to determine the annual net operating income for the
property. |
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Income |
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Gross Rents Possible |
100,000 |
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Other Income |
3,000 |
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Potential Gross Income |
103,000 |
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Less Vacancy Amount |
2,000 |
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Effective Gross Income |
101,000 |
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Less Operating Expenses |
31,000 |
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Net Operating Income |
70,000 |
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Once the net operating income is determined, a capitalization rate
is calculated for the property. If the above property sold for
$670,000, the cap rate is calculated like this. |
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NOI 70,000 |
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Capitalization Rate =
---------------- = --------------- = .1045 X 100 = 10.45
Rounded |
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Sales Price 670,000 |
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We have several other similar income properties that have recently
sold in the same area. There financial data is summarized
below.
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Comparable
No. |
Sales
Price |
Net
Operating Income |
Cap Rate |
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1 |
670,000 |
70,000 |
10.45 |
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2 |
730,000 |
75,000 |
10.27 |
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3 |
625,000 |
65,000 |
10.40 |
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4 |
705,000 |
77,000 |
10.92 |
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5 |
780,000 |
80,000 |
10.25 |
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We calculate a market cap rate by averaging the individual cap rate
data. The market cap rate for the above data equals 10.46
rounded. The appraiser would estimate the value of a similar
income property like this. He would go through the procedure
above to calculate the net operating income for the property in
question. Lets assume that the net operating income is equal
to 73,000. He would use the following formula to calculate the
market value
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Net Operating Income
73,000 |
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Estimated Market Value =
------------------------------ =
---------- = $697,897 |
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Capitalization Rate
.1046 |
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It should be noted that recent sales of similar property types may
be unavailable or very infrequent. For example, it may
be difficult to calculate a market cap rate for shopping centers
since there may be no recent sales. The income property
investor should have a good understanding of the income approach and
how a market cap rate is calculated.
If you are able to obtain a market cap rate for the type of property
you are analyzing, On Target can help you estimate the value of
other similar income properties. The On Target real estate
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(c) Copyright 2000 - 2008 Advantage Software
LLC |
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