What is the band of investment formula?
Band of Investment Formula Overview
The Band of Investment formula is a method used in real estate to estimate the value of an income-producing property. It combines the capitalization rates for debt and equity to determine an overall capitalization rate. This overall rate is then applied to the property's net operating income (NOI) to estimate its value. It's a method that accounts for both the cost of borrowing and the returns required on equity.
The formula involves:
- Calculating the Mortgage Capitalization Rate: This is done by multiplying the mortgage constant (the annual debt service divided by the total loan amount) by the loan-to-value ratio (the portion of property's value financed by debt).
- Calculating the Equity Capitalization Rate: This is found by multiplying the desired equity dividend rate (the return on equity investment) by the equity ratio (the portion of property's value financed by equity).
- Adding the Mortgage and Equity Capitalization Rates: The sum of these two rates gives the overall capitalization rate.
- Applying the Overall Capitalization Rate to the NOI: Finally, the property's value is estimated by dividing its NOI by the overall capitalization rate.
The formula can be summarized as:
This method is useful for investors in commercial real estate to evaluate investment properties, considering both the cost of borrowing money and the required equity returns.
