Written by Scott
How to Determine Capitalization Rate of a Property
Sometimes it is not feasible to try and determine what the cash flow is on a property. For example - because the terms and conditions will be different for any investor, we all will experience different results with regard to our interest rate and the length of a loan we decide to take on any given home.
Because of this, it is sometimes beneficial to determine a properties value based on a Capitalization Rate or Cap Rate. This is more commonly used in commercial properties, but can be applied to most any real estate purchase.
- The first thing you do to find the CAP RATE of a potential purchase property is to determine its recent sold price. If you don't have this, you need to get a comparable on the property to determine what it is worth.
Example: A six unit apartment complex that sold for $500,000
- Next, determine the Net Operating Income (NOI) of the property. This is sometimes called the Rental Income ( rent - expenses = net operating income).
Example:Income after all expenses are paid = $42,000
- Finally, Divide the NOI by the sale price to find the cap rate.
Example: $42,000 / $500,000 = .084 or 8.4% (The Capitalization Rate)
The lower the percentage, the less you will realize as a return on your investment. Basically, the higher the percentage, the more money you make when buying and the lower the cap rate the more you make when selling.