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).