To profit in real estate, investors must value the properties they buy, and then estimate how much money those properties will generate, whether through appreciation, rental income, or both. Two common methods for real estate valuation are the discounted net operating income and gross income multiplier approaches.
A property’s net operating income is the earnings it will make minus all reasonably necessary operating expenses. A property’s operating expenses include insurance, management fees, maintenance fees and utility costs. It does not include taxes and interest payments. The property’s total expected revenue must be determined, which can be predicted based on rents paid for similar properties nearby.
The gross income multiplier approach can find a property’s income-generating capacity. It assumes that properties in one area will be proportionally valued to the gross income they generate. Gross income is total income before any operating expenses are deducted. Vacancy rates must be forecasted, as well.
For example, if an investor buys a 100,000 square foot building, he may determine the average gross monthly income per square foot in the neighborhood is $10 based on comparable data from nearby properties. Assuming a 10% vacancy rate, the gross annual income would be $10.8 million.
To get the gross income multiplier, look at the sale prices of similar properties and divide that number by the gross annual income to get the average for the region.
Finding all the information you need to work these formulas can be very difficult, and neither method accounts for major changes in the real estate market. Still, the research will help you decide if a property is a worthwhile investment.