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Unformatted text preview: on to the return of deposit. This gain is referred to as the return on investment. • • • The capitalization rate is a composite of the rate of return on the investment and the rate of return of the investment. NET OPERATING INCOME
The income capitalization approach is based on the net income, or investment return, that a buyer expects from the property. The price that the buyer will pay will be determined by the probable return the property will yield from the investment. Remember that the income capitalization approach is based on net operating income, which is usually expressed as an annual amount. Compute the net operating income (NOI) – From gross annual income a vacancy factor is subtracted to establish an effective gross income, from which annual operating expenses are subtracted to arrive at the projected future net operating income. If a property’s net operating income for the year is known, as well as the buyer’s anticipated return for the investment (stated as a capitalization rate), value can be computed by using the following formula: Property Value = Net operating Income / Return (V = I / R) Dynasty School (www.dynastySchool.com) 12-11 REAL ESTATE FINANCE Example:
A buyer wants a 9 percent investment return. He is interested in a medical office building that produces a net operating income of $22,500 per year. What would the buyer be willing to pay for the building? $22,500 / 9% = $250,000 The property value necessary to produce the expected net operating income is $250,000. The return that can be expected based on an estimated level of income and property value can be computed by using a variation of the basic income capitalization formula: Return = Income / Property Value Example:
An investor estimates that a net operating income of $39,600 can be received from a building that will require an investment of $360,000. What is the investor’s capitalization rate (return)? $39,600 / $360,000 = .11 The expected return, based on the income alone, is 11%. A buyer who has only a certain amount to invest and wants a specific rate of return from his investment would use another variation of the form...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10