As stated in an earlier article, a rental property’s sale price (Value) and net operating income (NOI) are used to calculate an income investment’s capitalization rate (cap rate). Namely, NOI divided by Value equals cap rate.
The formula, however, also can be transposed to calculate the property value. Let’s say (for example) you have a cap rate rate and NOI and want to determine a property value, you simply divide the NOI by the cap rate to determine the price.
FORMULA: NOI/CAP RATE = VALUE
EXAMPLE: $10,000/10.0% = $100,000
When would you use this?
Suppose you’re trying to advise a seller the most reasonable market value for the seller’s rental income property. And based upon your research you find that recent sales of comparable properties average a 10.0% cap rate. Moreover, from information supplied to you by the seller, you know that the seller’s property would reasonably generate a net operating income of $10,000 annually. Viola! You divide the net operating income by the average cap and in turn advise the seller that a reasonable selling price for the property would be $100,000.
Obviously you can use the same approach to advise a buyer what you determine would be a reasonable price for an income property the buyer has an interest in. Either way, knowing how to transpose the cap rate formula to determine property price is an invaulable tool for any real estate agent or investor that works with income producing property.
