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.
a number of difficulties:
comparables and market information
Information relating to a sale of a commercial property is often confidential
and difficult to obtain. While the sale price can usually be determined,
the Income and Expense Statement, Net Operating Income etc. is often
not available, making it difficult to calculate the financial measures.
the underlying motives behind the purchase and adjustments that
may have been made by the purchasers.
The financial measures are simply ratios that have been derived from
the purchase price and the financial figures. They reflect the attitudes
and the results of the negotiations between the buyer and the seller,
economic conditions etc. In some instances, the purchaser may be strongly
motivated by income tax considerations, other times; the motivation
may be to move money into another country by an overseas investor.
Often, purchasers make adjustments to compensate for particular circumstances
relating to the particular property. As an example, if a purchaser
estimates that there is $250,000 to be spent immediately on major
repairs, then the $250,000 will be deducted from the purchase price.
Additionally, if the building has an assumable first mortgage, which
is well below the current rate, the purchaser may pay more for the
property than for a comparable property, which requires financing
at the current market rate.
the analyst is unaware of special buying or selling motives, or that
the purchaser has made adjustments to the price because of special
circumstances, such as the requirement for major repairs, or because
of favorable or unfavorable existing financing, then the calculation
of the financial measures will be incorrect. This will lead to erroneous
and misleading estimates of the market value for the subject property.
On the surface, the calculation of cap rates seems to be a relatively
simple process. However, it is fraught with difficulty and uncertainty,
and requires a lot of digging for information, questioning, and being
alert to special circumstances, which may distort the answers.
number of comparable is often limited.
Finding comparables for a residential property is relatively easy.
There are usually plenty of recent sales and an abundance of comparables
or near comparables. In contrast, there are relatively few commercial
sales, and finding comparables is very difficult because there may
not be many comparables available, and obtaining the information such
as the income and expenses may be difficult.
an example, finding comparables for a 5,000 Sq Foot, 10-year-old suburban
retail complex, which has five tenants with different lease renewal
dates and is situated in a poor location for retailers would be very
difficult. There is unlikely to be a direct comparable available which
has sold "recently." The approach in this situation is try to find
some sales that are at least close to this situation and then make
adjustments to try and take into account the specific differences
such as the timing of the lease renewals, locational factors, age,
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).
Service, i.e., principal and interest payments are ignored because
the Net Operating Income reflects the earning capacity of the property
exclusive of financing.
allowances or any other purely bookkeeping or Income Tax deductions
Expenditures which provides long term benefits such as replacing appliances,
painting of the building etc. are omitted.
The Cap Rate is calculated as follows:
Cap Rate = (Net Operating Income / Market Value) x 100
Cap Rate = (NOI / MV) x 100
Net Operating Income (NOI): $239,430
Market Value (MV): $3,420,000
= (239,430 / $3,420,000) x 100
Cap Rate = 7%
Rate of 7% represents the annual return before mortgage payments and
income taxes on the total investment of $3,420,000.
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
(NOI / Cap Rate) x 100 MV
= (105,000 / 7.5) x 100 MV = $ 1,400,000
Net Income Multiplier (NIM)
Income Multiplier (NIM) is the inverse of the Cap Rate
100 / Cap Rate
or Cap Rate = 100 / NIM
As an example,
if the NIM is 11, the Cap Rate is:
= 100 / NIM
100 / 11
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.
Income Multiplier is expressed as follows:
Net Income Multiplier (NIM) = Market Value / Net Operating Income
i.e. NIM = MV / NOI
Net Operating Income: $239,430
Market Value (MV): $3,420,000
NIM = MV / NOI
NIM = 3,420,000 / 239,430
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.