COMMERCIAL CALCULATION FORMULAS FOR INCOME PROPERY OWNERS

The net operating income of a property is the cash flow a property generates after expenses (but not debt service or taxes) are deducted. NOI is used to calculate property value using a capitalization rate.

The capitalization rate, or cap rate, is the rate of return used to determine the value of the property's income stream. The higher the cap rate, the lower the value of the property.

The most basic formula for calculating a commercial property's cap rate is Value = net operating income / cap rate. For example if a multifamily property has an NOI of $100,000 and sells for $1,250,000, the cap rate would be 8 percent ($100,000/$1,250,000).

A good way to determine a cap rate for a specific property is to find and compare recent sales of similar properties in the same market. By obtaining the purchase price and NOI from these sales, you can obtain a range of cap rates for the area.

Another measure of property value is cash-on-cash return, a.k.a. equity dividend return. This formula enables investors to determine the return on their equity in leveraged properties.

Cash on cash = before-tax cash flow (NOI minus debt service) / initial cash outlay.

For example, assume your initial cash investment to buy a property was $75,000 and your NOI this year after mortgage payments was $13,341. Your return would be 17.8 percent ($13,341/$75,000).

The same formula can be used to calculate after-tax return. Just subtract both the mortgage payment and the estimated taxes from your NOI.

The gross rent multiplier is an easy rule of thumb to forecast a value. Gross rent is the total rental income you could realize from a building if it were 100 percent leased. To calculate the gross rent multiplier, divide the gross rent into the sale price. If your projected monthly rental income is $12,000 and your sale price is $160,000, your GRM is $160,000/$12,000, or 13.3. You can also make this calculation using net income, which is total possible rental income less vacancies.

More sophisticated income analyses-such as internal rate of return, net present value, and discounted cash flow-calculate the present value of investment returns and rents received in the future. These calculations, which require a financial calculator, such as the Hewlett-Packard 12C, or a financial analysis software program, such as planEASE or Argus, are based on the assumption that money received in the future is less valuable than money received today.