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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.

 

  1. 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

  2.  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

  3. 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.

 

 

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