If your consideringÂ purchasingÂ or selling anÂ income producing property, then you must become familiar with the acronym "Cap Rate".Â
According to wikipedia, the Cap Rate is defined as "the ratio between the net operating income produced by anÂ asset and its market or cost value. The rate is calculated in a simple fashion as follows:
The Capitalization Rate or Cap Rate for short, is used by most investors, lenders and appraisers to help estimate the purchase price or value of an income producing property.Â An income producing property is any property that is purchased for rental use and not for personal use.Â In today's market a lot of new investors are purchasing single family homes, condo and town homes and using them as rental properties.Â If an investor has a pool of 10 units and another investor has a pool of 10 units, how would you go about valuing the assets to determine a purchase price?Â You would use a market cap rate, that is how.
Cap Rates are usually published by the major brokerage firms for various different income property groups such as multi-family residential, retail, industrial andÂ office.Â These cap rates are derived from sold properties and calculating the average cash-on-cash returns for each and ignoring any debt service obtained at the sale or purchase.
If you are a cash buyer, the cap rate provides your cash-on-cash return.Â If you are a leveraged buyer, the cap rate only provides the value of the asset, an additional calculation must be done to determine your yield or return after payment of your mortgage.
But how do you go about getting the parts needed to calculate the value of your asset using the cap rate?
Well let's use an example:
John has a 10-unit apartment building in Miami, Florida that he wishes to sell.Â He calls his broker and asks the broker to provide him a value for the property that he should sell at.Â The broker is provided the following:Â The average rent per unit is $500.00 per month.Â The average vacancy is 5%.Â The repairs, taxes and insurance are $300 per month.Â With this information, the broker can analyze and provide a value.Â This is how it would look:
Gross Potential Rent (monthly) $5,000.00 ($500 x 10-Units)
Less:Â Vacancy 5% $Â Â 250.00 ($5,000 x 5%)
Equals:Â Effective Rent $4,750.00
Less:Â Expenses $3,000.00 ($300 x 10-Units)
Net Operating Income (monthly) $1,750.00
In order to obtain the cap rate, you must convert the monthly net operating income into an annual net operating income.Â This is done by multiplying the monthly net operating income by 12.
Net Operating Income (annual) $21,000.00
Now we have (1) of the required components for the calculation, you need one more, that is the cap rate.Â The broker will now research the cap rate publications, call local lenders and appraisers and obtain a cap rate for similar properties that have sold in the area.Â For this example, we will use a 10.00% cap rate.
Now the broker can provide a value to the seller.
Net Operating Income $21,000.00 / Cap Rate 10.00% = Value $210,000.00
Now absent any additional information from the seller and the market, the broker will inform John that his property could potentially sell for $210,000.00.
Use of the cap rate in today's investment driven environment is very important.Â Knowing how much you are earning and how it compares to what others are paying, helps you to not overpay for a property or undersell a property you own.
With over 25+ years of combined experience, The Lifter Team and help you navigate through the waters of today's buyer's market and help you make an educated decision on your home purchase. Best of all, you get all of this service for FREE!
When we work with buyer's, our seller's cover 100% of our commission costs. So why would you try to buy your home without us, well that would just be plain silly!
Give us a call - 305-652-5506 x 101
The agents with the Local Touch!