Value as a function of CAP rate

In residential Real Estate, the value of a property is not directly connected with the return on the investments. When you buy residential there are many factors you consider and the possible rental income is only one of those, probably a minor factor unless you are an investor.

On the other hand, the main reason you buy a commercial property is the expected return on the investment so the value of a commercial property is heavily influenced by the yield of the property.

Value = NOI / CAP rate

 In Commercial RE Appraisers might use the Market Rate CAP rate to approximate the value of the property. Market CAP rate is an average of what similar properties are sold in that market ( approximately 6% in the Washington Baltimore area).

Value = NOI / CAP rate

An Investor might have in mind a different CAP rate than the market cap rate. To have an example if a property Rents for $200,000 and has operating expenses of $120,000

NOI ( stabilized ) = $80,000   if the cap rate for the area is 7% ( a possible cap rate in the Maryland  area for commercial properties ) . the value range of the property would be

$80,000/ 0.07  =  $1,1142,857

It could also be calculated using the Net Income Multiplier, essentially the same thing but it might be easier to use if comparing multiple properties

In this case the NIM is 14.28

Value=14.28*$80,000=$1,142,857

Another method Gross Rent Multiplier = Market Value / Gross Scheduled Income (annual) By transposing this equation, you also get: Market Value = Gross Rent Multiplier x Gross Scheduled Income (annual) The gross rent multiplier (GRM) is a very basic method by which you can estimate the market value of an income property. The advantage of the GRM is that it is so easy to calculate, the disadvantage is that is inexact.

MORE on USAGE of CAPITALIZATION RATE

Can we use the capitalization rate to find out how much a rental property added a room a bath or garage?

Well, lets assume we bought the property at 5% CAP rate.

If a garage adds $200 a month to the rent then it adds $2400 a year to the revenue

Now lets apply the formula above Value = NOI / CAP RATE

We have  Value=$2400/.05  = $48000 So if we can add the garage for less than $48000 is financially a good idea.