Why Determine A Real Estate Cap Rate?
If you are one of the hardy souls who are still investing in real estate, you have probably run across the term, cap rate, in your research. This is the real estate capitalization rate, which is can roughly determine the profitability of a property, or conversely, how much a profitable property could sell for. Now there is not a standard cap rate that means a property is a good investment, but rather the number is a guide that can be compared to the rate of other area properties.
Calculating A Propery Capitalization Rate
It is very simple to calculate the cap rate. You simply divide the net operating income (NOI) by the property’s market value. So if the income after expenses is $2,000, and the property is selling for $200,000, the cap rate would be 2,000/200,000 or .1, which is also stated as 10 percent.
CAP RATE = NOI / Property Value
What is a Good Cap Rate?
Of course, a seller will want the highest possible price, or the lowest cap rate. A buyer will want the lowest possible price so they can enjoy the highest capitalization on their purchase. Factors that determine an acceptable cap rate will vary, but the risk of taking on the property will be a consideration.
For instance, a seaside bar that enjoys a popular location may have a very high income, and also sell for a high price. However, if that particular location is subject to hurricanes every 3 years, the risk may be higher. That may bring down the sales price, so the cap rate will be higher, and the buyers will be compensated for their risk.
Using Cap Rate To Determine A Property Value
If you are buying a property, and you already have a good idea of the cap rate you think is acceptable, then you can use that information to roughly estimate the property value too. Take the Net Operating Income (NOI) divided by your goal cap rate. So if a property produces $12,000 a year, and you desire a CAP rate of .10, use the formule: 12,000 / .1 = 120,000.
Of course, it is up to you as a potential buyer to research reasonable capitalization rates, true net operating expenses, etc. In general a NOI is calculated by taking the gross operating income and subtracting out expenses like supplies, management, utilities, and property taxes. Improvements, which actually may raise the property value, are not considered.
