CASE STUDY 14 How to Estimate the value of Office Property Income Capitalization Approach This approach uses an estimate of value based on the rental income generated by an office property to indicate value. It uses a combination of market estimates for income, expenses, and a rate of return for an investor (the CAP rate) to determine value. Investors will consider numerous office properties to estimate the standard of how much is typically paid for particular cash flows in that area. The "going rate" in an area can be considered its CAP rate. For example, one investor may require a 10% return on investment or yield. Calculate how much the investor would pay for $100,000 in annual cash flows (NOI) to obtain the 10% desired return FORMULA: Price If the CAP rate is 10%, then Prices What is the Price? $ Another investor may require an 8% yield. What is she willing to pay for the same $100,000 of cash flows? FORMULA: Price = If the CAP rate is 8%, then Price =$ What is the Price? $ If a potential investor in an office building could alternatively invest in another building that yields 12%, there is no reason to invest in an office building that yields only 8% on cash flows of $100,000 To attract that investor, the property owner would have to lower the price (increase the CAP rate) to give that specific investor a higher yield of 12% FORMULA: Price = If the CAP rate is 12%, then Price = $ What is the Price? $ COPYRIGHT 2013. ALL RIGHTS RESERVED. COMMERCIAL REAL ESTATE ADVISORS, LLC