Investors new to commercial real estate are often surprised at the similarities that property valuation has with stock marketing. Learning how to calculate the net operating income and gross income multiplier, two basic economic models, of a property will prove to be invaluable when you are deciding where to invest. If you’re willing to do some simple math, the insight you will gain about real estate investment can profit you substantially in the future.
Ideally, you want a property that will generate a large amount of capital through property appreciation or rental income. One way to determine the income potential of a property is to calculate how much it is worth when factoring in operating expenses. You can do this by using the net operating income model: the total estimated earnings minus the operating expenses.
Operating expenses are determined by adding all the maintenance, management, utility and insurance fees necessary to keep a property running. Keep in mind that taxes and interest payments are not included in the final total. The total estimated earnings of a commercial real estate property can be determined by researching the rent of nearby properties.
The gross income multiplier model is valuable in determining how much income a property has the potential to generate. A more precise approach than simply comparing the rent of neighboring real estate, this value is calculated by first determining the gross income, or the total income before factoring in operating expenses.
Remember to factor in estimated vacancy rates when calculating gross income. By dividing the estimated monthly rent of a property by its square footage, you can easily calculate the average monthly income. Again, you should research the rent of nearby properties to determine how much you are willing to charge for your desired commercial real estate, rather than randomly choosing a value. Multiply the estimated monthly rent by the estimated vacancy rate to calculate the gross income of a property.
To arrive at the gross income multiplier, first research the sale prices of nearby properties to determine a realistic value for the one you have your eye on. Then divide that value by the gross income. This is the average income that the property is expected to generate.
Keep in mind that neither method factors in the frequent changes in the real estate market. In addition, researching accurate values for your calculations can be tricky. Consider recruiting a market professional for assistance and consult online web blogs for tips on how to conduct thorough research.
The net operating income and gross income multiplier will help you make an informed, smart decision when purchasing commercial real estate. New investors should utilize both models before making a final decision.