The formula is: Value = Net Operating Income (NOI) / Capitalization Rate. The appraiser calculates potential gross income, subtracts vacancy and collection losses for effective gross income, then subtracts operating expenses for NOI. Operating expenses include property taxes, insurance, maintenance, and management fees but NOT mortgage payments, income taxes, or depreciation. A lower cap rate indicates higher value.
An apartment building generates $200,000 in potential gross income. After deducting 5% for vacancy ($10,000) and $90,000 in operating expenses, the NOI is $100,000. Using a cap rate of 8%, the value is $100,000 / 0.08 = $1,250,000.
The income approach formula (Value = NOI / Cap Rate) is essential. Remember that mortgage payments and income taxes are NOT operating expenses. Know the inverse relationship between cap rate and value—as the cap rate decreases, value increases.
Related Terms
Related Concepts
A transfer tax is a tax imposed on the transfer of ownership of real estate.
Various programs and exemptions exist to reduce the property tax burden for specific groups, such as seniors, homesteaders, or veterans.
Depreciation is an accounting method of allocating the cost of an asset over its useful life, allowing investors to deduct a portion of the asset's cost each year.
Many states have laws to limit how much property taxes can increase each year, regardless of market value fluctuations.
Homestead portability allows homeowners to transfer a portion of their accumulated homestead tax savings to a new homestead in the same state.
Frequently Asked Questions
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