Erica Gonzalez 

TWO METHODS TO DETERMINE VALUE ON COMMERCIAL PROPERTY

CAP RATE

The question you're asking is a method used for commercial property valuation, which is called the Capitalization Rate.   

NOI divided by the purchase price or mkt value = Cap Rate.   Looking to the NOI and Cap Rate will help determine the potential return and, thus, whether the investment is worthwhile. 

GROSS RENT MULTIPLIER

The other way to determine value is the Gross Rent Multiplier.   Divide purchase price by gross rent.

I R V is the formula. 

I = Net Operating Income (gross minus expenses) 
R = Cap Rate
V = Value 

You can multiply or divide, depending on what you're looking for.

EX 1: NOI is 100k annually, divide by [known] cap rate 8% value is 1250000
EX 2: Value (or asking) is 500k, NOI is 25k, divide 25000 by 500000 that's a 5 CAP

EX 3: Cap rate 10% (if that's what your guy wants) value 500k, x 10% so you need NOI of 50k annually for it to pencil. 

I have answered this question soooo many times, LOL 
Keep this and you will never go wrong. 

NOI  

Income, say it's rents then it is market rents determined by the appraiser, generally not short term rental unless is a refinance and they can prove the past two year track record.

Minus: advertising, car, commissions, contract labor, depreciation, employee benefit programs, insurance, mortgage interest, legal, office, taxes.... etc (every little line item for the year - equals the net).

Profit and or Loss - lenders use this from the last tax return to the current date. This is how we measure that a business is still making the same money as on the past two year IRS cycles. The income needs to be the same or increasing or in the evaluation process the business appears to be in trouble. The YTD (year to date) profit and or loss is not included in most income calculations for conventional and government loans. It is used in Non QM, Commercial, multifamily.  When a buyer is making an investment property purchase we also look at track record. If this is the first rental and loan is conventional the appraiser will do a rental survey which is the income number used against principle, interest, tax, insurance and HOA less a 25% haircut on the income. We want to see that the income verses the hard expenses monthly can be met with rents. Vacancy and problems occur so the 25% expense margin is for say a property manager who may charge 10% and tenants who don't pay... 

Profit and or Loss sometimes we ask for the CPA to provide verified numbers. Other times the borrower who uses quickbooks can run the current numbers from their own books. 

If property Net Operating Income is  a big loss, we may ask for larger down payment to make it work, or ask for more reserves on a different program, or say no. Call me if you need help

Contact a broker in your local area that can help you Erica. The best to you in getting the answers you need.

The NOI, net operating income (subtracting all expenses from total revenue) That's what's to put into Hip National Bank (your pocket, so to speak)

Your NOI is the amount of Income that is left to Service the Debt ( Mortgage Payment)

Now that you have the formula, I hope the class also asks you to calculate as well. It is in the doing that we learn. My mother always said, not tell me, show me. 

I wish you all the best with your real estate studies. 

Best to sit down with a broker and look at examples of real numbers to truly understand it.

The giants are out and answering up. Real meat & potatoes here. ME: I never like these formulas as my brain is simple as is my approach however, these are good to know when you need them. Keep asking questions until it gels

Brian L. Sirota, Esq. and Candice A. Donofrio have you covered. Good luck!

This is not a matter of opinion or experience. It's a textbook answer. 

Hi Erica, looks like you have some good explanations here, all the best to you on your exam.

Bob

I only use the CAP Rate method on all residential property aka Capitalization Rate - however basically same data, with more detail.