What is the Band of Investments Method?
The phrase “Band of Investments” refers to a method used by commercial appraisers or investors to calculate a rate known as an overall capitalization rate. This rate is then used to convert the net income produced by a property into an indication of value.
Here is a brief explanation of how it works.
Few purchasers or investors have the cash on hand to purchase a commercial building. Or, they may just want to enjoy the effects of positive leverage. As a result, most of the money is often borrowed from a bank or other lender. The rest will be paid out of the investors pocket. The bank expects the borrowed money to be paid back over time. Their reward will be the interest paid on the borrowed funds. The investor also expects to be rewarded. Their reward will be the money that remains after paying that debt.
Thus, there are two components to most commercial property investments; a debt component and an equity component.
Here’s the math behind the concept:
Debt Component %
Plus: Equity Component %
Equals: Overall Capitalization Rate %
The math involved in calculating the debt and equity components of the overall capitalization rate can get a bit complicated, so I won’t explain it here. But the result of dividing the net income by this rate will provide an indication of value, a price that can be paid for the property that will result in an income stream sufficient to satisfy both the lender (debt) and the investor (equity).
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Alex Brosky says
Well Stated Russell!
RussellRoberts says
Thanks Alex! :)
Mike says
Russell, thanks for the explanation. I was wondering if band of investment has any residential applications that would be valid? I’m reviewing a residential appraisal and the appraiser used the BOI to extract an adjustment for the environmentally “green” attributes of the LEED Platinum rated subject property. It makes sense to me but it seems to have no valid support in the residential market. Thx. Mike
RussellRoberts says
Mike,
Quantifying the effects of “green” savings on the value of residential homes is an emerging field and I’m not sure that there is one accepted standard. My forte’ is commercial properties. But the methodology you described sounds solid. I would certainly use the same methodology as the appraisal you are reviewing in a commercial appraisal but we have a little more flexibility than residential appraisers.
At this stage of the game of valuing green homes, I would say that market support from sales for any sort of adjustment for energy savings would be scarce as hen’s teeth. That’s the challenge facing residential appraisers. I certainly believe that capitalizing the savings using the Band of Investments method would be a valid and logical method in the absence of data from sales.
I hope that answers your question, Mike.
Lucky Lawrence Ibive says
The subject property has an income of $30,000. In the mortgage market for this type of property, the best rate available is 9% interest per year with monthly payments, a 25-year amortization, and a maximum 75% loan-to-value ratio. The equity dividend rate is 15%. What is the market value? Use the band-of-investment technique and round your answer to the nearest $1,000.
$325,000
$300,000
You Answered
$275,000
Correct Answer
$265,000
The correct calculation is:
(0.75 × 0.1007 = 0.0755) + (0.25 × 0.1500) = 0.1130
30,000 / 0.1130 = $265,487
How do they come up with the highlighted items?
I know that you don’t have to help me with the problem.
Thank you so much, I really appreciate your help and time
Lucky Ibive
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James R Young says
One of the originators of the method was Dr. Thurston H. Ross who I had the privilege of working for over five years.Ji