One very popular and quick method of estimating a commercial property's valuation is using the specific market's Cap Rate for the type of property using the following formula: Cap Rate (%) = Annual Net Operating Income / Purchase Price. As with any simple algebraic equation, if you know 2 of the numbers, it is very simple to determine the 3rd. The NOI (Net Operating Income) includes normalized operating revenues and expenses, but excludes depreciation, amortization, interest expenses and income taxes, as these are investor/owner specific and would lead to comparisons of apples to oranges etc..
Let's use the example of a multi-unit residential building to illustrate the valuation process. Assume the apartment building has a normalized annual NOI of $150,000 and the current market cap rate of 5.5 %. Reconfiguring the above formula, the building's estimated valuation is $150,000 / .055 = $2,727,273. Please note that cap rates vary over time and are specific to a location and the type of building generating the NOI.
Although the Cap Rate is the most popular listing or advertised data for commercial buildings, it does have a number of serious shortcomings as follows. Firstly, It assumes that the NOI continues at the same annual rate forever, and secondly, it ignores the future sale of the property. Finally, it does not include the individual investor's financing and income tax positions, both of which are extremely important when analyzing any potential investment property. For these reasons, seasoned investors normally use the Cap Rate Method of Valuation simply to determine if a specific property merits spending more time doing an in-depth analysis, such as calculating the discounted Net Present Value and Specific Term Blended Internal Rate of Return.
The Cap Rate, in addition to be used as a valuation tool, is also used in comparison of two or more investment real estate properties. For example, the first property has a cap rate of 6.00% while a second one has a 8.00% cap rate. All things being equal, therefore, the second one provides more Net Operating Income per Dollar of Cost.
Copyright © 2014. R. Mike Mullin, CPA, CGA. All rights reserved.
R. Mike Mullin, CPA, CGA The Real Estate Investor's Best Friend!!!
Personal Real Estate Corporation, Branch Manager
Commercial & Investment Realtor® Serving Ladysmith, Nanaimo, Comox Valley, Campbell River & Port Alberni
Pemberton Holmes Ltd. 535 - 6th Street, Courtenay, B.C. V9N 1M5
Direct Line: 1-250-650-6560
1) Income (Investment) Method
2) Cost Method
3) Comparative (Market) Method
4) Residual Value Method
Focusing on modular/mobile home parks, residential rental properties, apartment buildings and investment real estate on Vancouver Island,
from Ladysmith to Campbell River including Nanaimo, Courtenay, Comox, Comox Valley, Campbell River and Port Alberni
As the main reason to consider buying an investment property is to get a Return on Investment, I will only describe the Capitalization Rate here. This rate is the most basic Income Method of property valuations.
R. Mike Mullin, CPA, CGA - Licenced Commercial Realtor® - throughout BC
Commercial Properties, Investment Properties, ICI Properties, Distressed Properties
Homes with Suites, 3 Plexes, 4 Plexes, Residential Apartment Buildings, Modular/Mobile Home Parks, Foreclosed Properties
Serving Ladysmith to Campbell River including Nanaimo, Courtenay, Comox, Campbell River and Port Alberni
Look before you leap has never been truer than when considering a significant purchase of commercial or investment real estate. You need to be reasonably certain that you will achieve a profitable return on your investment and the only way to ensure this is through due diligence. In other words, you have to run the numbers.
Mike's CGA experience and financial background enables him to present you with the financial information you need to make a qualified decision. Mike is based on Vancouver Island and specializes in commercial real estate and investment properties on the Island. He knows Vancouver Island's commercial real estate market extremely well and can present you with investment properties that meet your specific requirements or list you commercial real estate and bring in qualified buyers. Mike is also a Commercial Mortgage Broker who can assist you or your potential buyers in obtaining suitable financing to cap off a winning commercial real estate investment deal.