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Posted
by Jace Stolfo
on Wednesday, May 27th, 2009 at 5:37pm.
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The most commonly used approach when valuing Idaho income properties is the *capitalization approach*. Most residential sales use the *sales comparison* approach by finding sold "comps". The capitalization approach on the other hand looks at the potential* annual net operating income* and market "*cap rates*" to determine value. Below is an overview of how this process works.

There's three parts to the formula: Income, Rate, and Value. I remember this by thinking "IRV" and having memorized this formula:

Income */* Rate = Value

**Step 1: Determine Income (Annual Net Operating Income: "NOI").**

To determine a property's annual NOI, you'll take gross rents less expenses.

Here's an overview of how this looks:

**A) Gross Operating Income:**

- Less Vacancy and Credit Loss (5%+/-).

**= Effective Income**

**B) Annual Operating Expenses:**

- Insurance - Maintenance & Repair - Property Taxes - Property Management - Utilities - Advertising

Please note: You do not include income taxes, only expenses related to the Idaho property.

**Net Operating Income (NOI)** **= Effective Income - Annual Operating Expenses.**

This sounds simple until you begin to distinguish *actual* income verses *potential.* While the value is based on potential, you'll have to verify that the advertised numbers are not inflated and compare to the historical performance of the property or similar properties.

**Step: 2 Rate**** (Capitalization Rate)**

The capitalization rate is represented by a percentage (generally 5% to 10%) and is determined by the market. For example, if a property sold for $500,000 and had annual NOI of $50,000 the cap rate would be 10% (sales price divided by the NOI). If that same sold property had an annual NOI of $25,000 the cap rate would be 5%.

The market will accept a lower cap rate on Idaho properties that have solid long-term tenants/rental history. If properties have a poor rental history the market will require a higher cap rate.

**Step: 3 Determine Value**

Again, here's the formula: Income / Rate = Value

**Example #1: **If the market cap rate on office properties is 8%. And the property you're evaluating has an annual NOI of $40,000, what's the value of the Idaho property?

Answer: $40,000/.08 = $500,000

**Example #2:** If you see an Idaho property for sale for $400,000 and they advertise an NOI of $30,000, what's the cap rate on the property?

Answer: $30,000/$400,000 = 7.5%.

**Example #3:** An Idaho property is advertised for $750,000 and you see "10% CAP RATE" advertised on the flyer. What would the NOI be?

Answer: $750,000 x .10 = $75,000.