Income Property Valuation Using Capitalization Rates

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Capitalization Rate, or Cap Rate, is a calculation tool used to value real estate, mostly commercial and multi-family properties. It is the NOI, Net Operating Income of the property divided by the current market value or purchase price. Serving your real estate investor clients, you'll need to be able to aid them in the valuation of income properties.

A common method used, among others, is the capitalization rate, or cap rate. Once your client has an income property under consideration, you can help them to see if the asking price is justified by using the current cap rate for comparable properties and the net income this property generates.

Determine Property Income That Justifies the Asking Price

If your client knows the asking price of a property and the current cap rate for similar properties, you can calculate the net rental incomes necessary to justify the asking price. If you want to determine the income the property should generate to justify the asking price, here is the calculation method.

Know the Calculations With Capitalization Rate to Properly Serve Your Investors

Real estate investing has enough risk without your clients taking on more by purchasing over-valued income producing properties. Part of your value as a real estate agent or broker is to assist them in determining the true value of a property. Using the capitalization rate is one of the various valuation tools, and you'll learn how to use them at the links in this profile of the cap rate tool. What are some of the other calculation tools used in commercial and residential property valuation?

  • NOI, Net Operating Income:  As a real estate professional serving investment clients, you need to be very familiar with all the methods of valuation of income properties. One of these is the calculation of Net Operating Income, as it is used with cap rate to determine the value of a property.
  • Net Rental Yield:  The beginning of a successful rental property investment strategy is an accurate estimate of rental yield for the prospective property. Here we see how to calculate Net Rental Yield, which takes the property expenses into account, though not the mortgage payments.
  • Gross Rent Multiplier:  As a real estate agent working with real estate investors, you will likely be doing quite a few market value analysis calculations for each property finally purchased. The Gross Rental Multiplier (GRM) is easy to calculate but isn't a very precise tool for ascertaining value.
  • Cash Flow of a Rental Property:  If you came to this article in a search, it is part of our Rental Property Investment Analysis. Start there to walk through a detailed analysis of a sample property.
  • Gross Potential Income: We want to know what income will be realized if a property is fully occupied and all rents are collected. We take the number of units times annual rent for a total. 
  • Gross Operating Income, GOI:  Once we know the Gross Potential Income of a real estate investment property, we arrive at the Gross Operating Income by subtracting out the estimated annual losses due to non-payment or vacancies.
  • Depreciation of a Rental Property:  In our series on Rental Property Investment Returns, we're using an example fourplex as our investment. You can get the purchase details here, however, remember that it was a $325,000 purchase of a fourplex for rental of all four units full time.
  • Breakeven Ratio for Rental Property:  Lenders use the break-even ratio as one of their analysis methods when considering providing financing for a real estate investment property. Too high of a break-even ratio is a cautionary indicator.

The beauty of real estate investment is that there are these reliable calculation tools to evaluate your investment.  If they come together to tell you that you're looking at an opportunity, you may want to take advantage before it goes away.