HOW TO CALCULATE CAP RATE
HOW TO CALCULATE CAP RATE
NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
When dealing with real estate investing, you will hear the term capitalization rate (cap rate) quite often. Capitalization rate is a way of determining rate of return on an investment property. Basically, this is the ratio of NOI (net operating income) to property asset value. Investors, real estate agents, appraisers, property tax assessors, lenders and other real estate analysts use the cap rates in 3 different ways. 1. To compare similar income properties in an area. In this case the higher the cap rate, the higher the return and thus the better the investment. 2. To make an estimate of the purchase price for different income producing properties. 3. To calculate an income property’s net operating income ( NOI ). It’s important to know that capitalization rates are directly affected by interest rates and correlate when they rise of fall. Also Cap Rates vary from one area to another and from investor to investor. So, how do you calculate cap rate?
Calculating the Capitalization Rate 1. Calculate annual gross income First you need to calculate the property’s annual gross- income. For many investment properties, gross income is just the rent. However, in certain cases the property can generate cash from some other sources, like a coin operated washing-machine. For example, if one apartment rents at $1,200 per month, gross income is $ 14,400 per year. 2. Get the annual expenses Add up the annual expenses of the property. Every rental unit has its own operating costs. The costs may include hazard insurance, property taxes, property management fees and maintenance bills. NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
For example, if you pay $850 in property taxes, $750 in maintenance and $800 in insurance every year for the rental unit, then your total annual expenses equals $2,400 3. Calculate the Net Operating Income To figure out the Net Operating Income, you will have to subtract annual expenses from your gross annual income. Take an example of an annual gross income of $14,400 and annual expenses of $2,400. This will give a NOI of $12,000. 4. Determine the property’s estimated market value The next step in determining Cap Rate is to find out the market value. This is similar to the asking price for the property. 5. Get the ratio Divide the net operating income by the market value of the property. Suppose the apartment has an asking price of $150,000, divide the Net Operating Income of $12,000 by $150,000. This will give you 0.6. 6. Get the percentage Convert your decimal figure to percentage. In the above example, the capitalization rate you got (0.6) is equal to cap rate of 6 %. The lower the cap rate the higher the value of the property, and conversely the higher the capitalization interest rate the lower the value of the property. Therefore rates of capitalization have an inverse relationship to value.
NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
When dealing with real estate investing, you will hear the term capitalization rate (cap rate) quite often. Capitalization rate is a way of determining rate of return on an investment property. Basically, this is the ratio of NOI (net operating income) to property asset value. Investors, real estate agents, appraisers, property tax assessors, lenders and other real estate analysts use the cap rates in 3 different ways. 1. To compare similar income properties in an area. In this case the higher the cap rate, the higher the return and thus the better the investment. 2. To make an estimate of the purchase price for different income producing properties. 3. To calculate an income property’s net operating income ( NOI ). It’s important to know that capitalization rates are directly affected by interest rates and correlate when they rise of fall. Also Cap Rates vary from one area to another and from investor to investor. So, how do you calculate cap rate?
Calculating the Capitalization Rate 1. Calculate annual gross income First you need to calculate the property’s annual gross- income. For many investment properties, gross income is just the rent. However, in certain cases the property can generate cash from some other sources, like a coin operated washing-machine. For example, if one apartment rents at $1,200 per month, gross income is $ 14,400 per year. 2. Get the annual expenses Add up the annual expenses of the property. Every rental unit has its own operating costs. The costs may include hazard insurance, property taxes, property management fees and maintenance bills. NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
For example, if you pay $850 in property taxes, $750 in maintenance and $800 in insurance every year for the rental unit, then your total annual expenses equals $2,400 3. Calculate the Net Operating Income To figure out the Net Operating Income, you will have to subtract annual expenses from your gross annual income. Take an example of an annual gross income of $14,400 and annual expenses of $2,400. This will give a NOI of $12,000. 4. Determine the property’s estimated market value The next step in determining Cap Rate is to find out the market value. This is similar to the asking price for the property. 5. Get the ratio Divide the net operating income by the market value of the property. Suppose the apartment has an asking price of $150,000, divide the Net Operating Income of $12,000 by $150,000. This will give you 0.6. 6. Get the percentage Convert your decimal figure to percentage. In the above example, the capitalization rate you got (0.6) is equal to cap rate of 6 %. The lower the cap rate the higher the value of the property, and conversely the higher the capitalization interest rate the lower the value of the property. Therefore rates of capitalization have an inverse relationship to value.
NESRINE “NISSA” ELJOR C: 949.307.5533 HEC CRE BRE # 01948739 [email protected]
