Income and expense figures are used to establish values for income properties. These figures should reflect the current market conditions in a given geographical market area, given normal or typical management of the property. Specific, actual figures should be used whenever possible. If this information is not available, then typical figures for the specific market should be used. Neighborhood data can be collected to estimate typical rents, vacancy, and expense ratios.
Gross income is the total rental income for a property, less any vacancies, plus any other miscellaneous income. The property’s net operating income is the gross income less typical operating expenses.
Obviously, it is best if you are able to locate similar properties in similar neighborhoods to do your comparisons. If you can locate properties that have sold, using their multipliers and overall capitalization rates can help you arrive at a value for another property. Cap rates are widely used in real estate because they provide a simple and consistent method to determine a percentage return on investment. Realtors and investors determine pricing for an investment given an expected rate of return.
Typically investors add or subtract from the financial calculations to adjust for varying amenities. Location, age, condition, recent capital improvements, curb appeal, all play an additional role in the evaluation process. When a Realtor evaluates a building the process is often as much an art as a science.
Like anything else, once you become familiar with the terminology and practice, the calculations for the value of income properties become easier. Realtors often develop short cuts to quickly analyze a property “by the seat of their pants.” The most common is the Gross Rent Multiplier (GRM). This is normally used to determine if a property deserves a closer evaluation and consideration.
Eric Ruxton and Larry Aikins are the owners of Terrace Realty Inc. and Terrace Associates Inc., in Redwood City. Terrace has been in business for over 50 years and in addition to being an independent Brokerage Company, also owns and operates rental properties.