Commercial Real Estate: Estimating Income-Producing Property Values

Instructor: Victoria Fitch

Victoria has trained hundreds of professionals in real estate, and holds a Master's degree in Real Estate from Johns Hopkins University.

What are valuation models for income-producing properties? In this lesson learn how to determine the value of real estate based on the income stream, as well as how capitalization rates (cap rates), gross income multipliers and comparable price valuations are involved.

What is Income-Producing Property?

Income-producing properties are a great way to increase the yield of a real estate portfolio, but these properties still must be valued carefully. Evie is a real estate investor looking to purchase Ridgely's Delight, a mixed-use development comprised of an indie movie theater, tapas restaurant and 32 apartments. With a hefty price tag of $4 million, Evie is trying to determine if the income stream is sufficient to support the asking price.

The process Evie uses to determine a property's value is based on several steps, for income-producing property the value is related to the property's ability to produce cash flow, versus the value of the physical structure or land.

Gross Income Multiplier Method

When an income-producing property is available for sale, the seller will supply a rent roll as part of the due diligence package. The rent roll lists every rentable space on the property, if it is occupied, as well as the amount of rent collected on a monthly basis.

Evie can use the rent roll to establish the gross income and then apply a gross income multiplier to determine the total value of the property.

Gross income multiplier = Sales price / Gross income

She can multiply the gross income multiplier by the gross income to find the value.

Value = Gross Income Multiplier * Gross Income

Evie used the multiple listing service (MLS) to find recent sales of similar properties to determine the market rate gross income multiplier.

Ridgely's Delight Comparable 1 Comparable 2 Comparable 3
Value ? $3,780,000 $3,950,000 $4,280,000
Gross Income $625,000 $528,000 $575,000 $625,000
Gross Income Multiplier ? 7.16 6.87 6.85

Evie recognized that the age and condition of Ridgely's Delight put it somewhere in the middle of the comparables, so she used a multiplier of 6.90. Since she had the gross income from the property, she was able to simply multiply the gross income times the gross income multiplier to arrive at a value of $4,312,500.

Direct Capitalization Rate Method

With this information in hand, Evie went out into the field to conduct a visual inspection of Ridgley's Delight and the three comparable properties.

She noticed that one of the properties had a really beautiful common area with a fountain, which could affect the operating expenses of the property. So she decided to adjust her valuation using the direct capitalization rate method, which accounts for variation in operating expense by using the net operating income to determine value. The formula is:

V = I / R


  • V = Value
  • I = Net Operating Income
  • R = Cap Rate

Ridgely's Delight Comparable 1 Comparable 2 Comparable 3
Value ? $3,780,000 $3,950,000 $4,280,000
Gross Income $625,000 $528,000 $575,000 $625,000
% of Operating Expenses 39% 40% 42% 41%
NOI $375,000 $316,800 $333,500 $368,750
NOI÷Value = Cap Rate ? 8.4% 8.4% 8.6%

She was pleased to see that even with the additional common area amenities, the capitalization rate (cap rate) was aligned across the properties. She applied the 8.4% cap rate to Ridgely's Delight, then took the net operating income (NOI) and divided it by the cap rate for a total value of $4,464,000.

Evie was surprised and excited to find that the $4 million price tag provided an opportunity for instant equity based on the income valuation models. She will definitely move forward with her purchase!

Risk Factors

In the due diligence period, Evie needed to consider the risk factors. She paid special attention to market trends in the retail and residential markets. She surveyed her local market for potential competitors that could force her to lower rents and thus lower the gross income for the property. She did not find any immediate threats, but would have discounted her cap rate to factor in the potential for lower rents.

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