Methods of Valuation
There are 3 key areas that would impact the value. Like a 3-legged stool, all 3 must make sense to for the investment to stand straight.
- Income from the property
- Operating expenses of the property
- Financing terms
Method 1: Gross Multiplier
Price divided by Income. G=P/I.
This is a simple way of comparing multiple investment opportunities. It does not take into account the Operating Expenses, and Financing.
Method 2: Price per square foot
This method does not take into account any of the above 3 factors.
Method 3: Capitalization Rate
Net Operating Income divided by Price. R=NOI/P.
This is a common method used to value properties. It does take into account Income and Operating Expensed. However, Financing is not considered.
Method 4: Cash on Cash
Cash flow before tax divided by Cash Invested.
This method results in a rate of return to be used as a tool to compare investment opportunities. It takes into account all 3 above factors. However it is not an easy way to arrive at a value.
Method 5: Financial Management Rate of Return
The FMRR method takes in to account Income, Operating Expenses, and Financing. It paints a complete picture of the investment opportunity from acquisition to disposition detailing before and after tax cash-flows for every year of the ownership, and the overall rate of return of the investment when you sell or exchange for anther opportunity.
The analysis also is used as an aid to assess whether the performance of an investment is on track with the investment objectives.