Income value method — Determining the value of investment properties
What is the income value method? - The definition
Die Income value method is a method for valuing real estate that generates rental income and is used to determine the value of a rented property based on the income that can be achieved in the long term. This method is particularly relevant for buyers and banks, as it provides information on whether the investment is justified by the earning power of the property. The income value method is often used in apartment buildings and commercial properties, such as office buildings, shopping centers and hotels.
The calculation is made by multiplying the annual net rental income by the capitalization factor, which takes into account the risk and performance of the property. A low capitalization factor results in a higher income value, while a higher factor decreases the income value.
How to calculate the income value of a property
The calculation of the income value is based on the assumption that the property generates stable rental income over the long term. For this purpose, the annual net rental income is divided by the capitalization rate and multiplied by 100.
instance: With annual net rental income of CHF 100,000 and a capitalization rate of 5%, this results in an income value of CHF 2 million. In this calculation, the capitalization rate is the value to which real estate income contributes sustainably to income expectations.
Importance of the capitalization rate
The Capitalization rate is a decisive factor in income value calculation and consists of various components. It is based on a reference interest rate for risk-free investments, such as the interest rates of 10-year federal bonds, and includes premiums for risks such as vacancy and maintenance costs. Because vacancy and future performance depend largely on the situation, this characteristic has the biggest influence on it. A higher capitalization rate signals an increased risk or higher costs and reduces the income value of the property.
Since setting the capitalization rate is complex and depends on many factors, it is advisable to involve experts in the calculation. Even minor adjustments can have a significant impact on income value.
For which properties is the income value method suitable?
The income value method is particularly suitable for investment properties, i.e. for real estate that serves as a capital investment through rental income. The relevant types of real estate include:
- multi-family houses: Rental building with several residential units.
- commercial real estate: office buildings, shopping centers, hotels, restaurants and practices.
- Mixed real estate: Real estate with a mix of residential and commercial spaces.
note: The income value method often requires subjective assessments, such as market and vacancy risks. Since fluctuations in the capitalization rate strongly influence the income value, an expert's assessment is advisable.
Comparing the income value method with other valuation methods
Because of its basis in real rental income, the income value method is a practical valuation method, which, however, has special features:
- Sustainability of rental income: Since the income value depends on rent rates, it is important to check their sustainability. Planned new buildings or renovations nearby can influence rental income and should be taken into account. On the other hand, properties in emerging regions can benefit from rising rental income without investments.
- Impact of interest rate changes: Rising interest rates increase the capitalization rate and lower the income value. At the same time, the reference interest rate for long-term rental contracts allows rent rates to be adjusted, which can increase the income value.
While the income value method is ideal for investment properties, other valuation methods such as the net asset value method or the net present value method are used for residential properties, where the income aspect plays a lesser role.
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