Real Estate Investment
How Do I Know What to Offer in the Central Florida Housing Market ?
The most common method of determining the value of an investment property and thus how much to offer is by determining the “Cap Rate” and applying it to desired returns. The method is rather simple and can be done quickly – in a matter of minutes – if you know the “facts”. Many investors have a simple spreadsheet ready for data insertion.
First take the total possible rent that can be obtained if the property were fully rented – for duplexes – both units, for quads – all four. For single family homes it would be just the one. For a shopping center it would be the total gross leaseable feet. Next subtract at least a month’s rent loss as a percentage (1/12 or 8.3%) on the entire property – including all units. Generally, you cannot re-rent a unit or property once a tenant leaves without some downtime in between. One month is the minimum we use – hence the 1/12 deduction. By subtracting 8.3% from the total – you have what you estimate will be the actual income of the property.
If there are other sources of income from the property such as coin laundry machines, billboard signage, cell tower royalties add them as “other income” – but add only the net income from these operations.
These two numbers together give you what is termed – the Effective Income.
Next take all of the operating expenses for the property as applicable and list them with their correlating number. These would include management fees, property taxes, utilities, insurance, reserves for repairs and replacements and the like. It does not include debt service. Loan payments or interest expense on a loan is not considered an Operating Expense.
Next simply deduct the Operating Expense from the Effective Income. This number is referred to as the Net Operating Income or NOI.
The final steps are more subjective as they involve the comfort level of the investor.
The investor then has to choose the desired return rate. Because the NOI is “fixed” the desired return on the investment is directly related to how much the investor should pay for the investment property.
If the investor wants an 8% return and the NOI is $4500, then the investor should pay no more than $56,250. This “value” is obtained by dividing the NOI ($4500) by the desired return (.08). If the investor will only take an 11% return then the offer should not exceed $40,909.
For more information and to see a sample spreadsheet click here.