Module 4: Income Capitalization Formulas

Question 1

I/R=V Formula

Answer 1

I = income
R = Rate
V = Value

if seeking the value of the property based on net operating income then the rate used is referred to as an overall rate.

Overall rate is the most frequently used in the I/R=V formula when performing direct capitilization

Question 2

Factor or Rate

Answer 2

whether a factor or rate is used to determine a value depends on the property type and data available

Question 3

Multipliers

Answer 3

PGIM - potential gross income multiplier
EGIM - effective gross income multiplier
NIM - net income multiplier

Question 4

Which multiplier to use

Answer 4

Any or all of them; it ultimately depends on the property type, how the market looks at a property, and the data available for analysis

Question 5

Mulitpliers formula

Answer 5

VIF = value = income x factor

versus not IRV = I/R=V

Question 6

Factors and Rates

Answer 6

Any factor can be converted to a rate by simply taking its reciprocal (R = 1 / F), but this derived capitalization rate (R) is not an overall rate (RO) unless it is based on NOI.

Question 7

If an overall capitalization rate (RO) is 6.25%, what is its corresponding factor?

Answer 7

The answer can be found by taking the reciprocal of 6.25%.

1 ÷ 0.0625 = 16, so 16 is the factor that corresponds to a capitalization rate of 6.25%. You can crosscheck your work by taking the reciprocal of 16, which turns out to be our original capitalization rate of 6.25% (i.e., 1 ÷ 16 = 0.0625).

Question 8

When most commercial property investors refer to rent for this property type, they do so on an annual basis. A 16-unit income-producing property would therefore be viewed and analyzed by an appraiser on the basis of the next 12 months’ gross income. In this case, the 16 units will generate a potential gross income (PGI) of $124,800 during the next 12 months.

This 16-unit apartment building has a potential gross income of $124,800. The vacancy rate [help] is 5% and the operating expenses and replacement allowance [help] is $40,000. If the overall capitalization rate is 8.25%, what is the value by direct capitalization?

Answer 8

To use IRV, we need the net operating income (Io). This problem gives us the PGI, so we need to first calculate IO.

Step 1: $124,800 PGI - $6,240 (5%) vacancy = $118,560 EGI
Step 2: $118,560 EGI - $40,000 operating expenses = $78,560 IO

To solve this problem algebraically, use the following:

EGI = PGI x .95
EGI = $118,560

EGI – operating expenses = NOI
$118,560 - $40,000 = $78,560 (NOI)

Now, apply I = R x V, solving for V

78,560 / .0825 = V