How does the cap rate figure into your buying decision? Do you base whether to buy or sell based on this number? If the cap rate is lower, then the property is more expensive right? Do you have a better chance of getting a better deal when you have a higher cap rate?

Capitalization (Cap) Rate - rate of return used to derive the capital value of an income stream, divide annual income by net operating income.

Cap Rate = (Net Operating Income / Market Value) x 100

;D

The cap rate tells you if the place is making any money.
Or Rate of Return

Bruce

If I don’t see a cap rate of atleast 10 using high expense estimates I don’t even bother looking any further.

Patrick: Downtown Seattle Commercial CAP rates are running just shy of 5.5% and creeping downward, with outlying areas still around 6.5%-7%. So many of the deals I see listed at commercialmls.com and loopnet are expecting 40%+ down, but the cash on cash return is pitiful.

You’re fortunate to be working with an area that still has decent CAP rates. I keep looking here and, being new to all of this, I know I’ll find something at some point that bears fruit.

Wow, are you able to find many using high expense estimates?

Using between 35-40% expense…a fair amount.

35-40% expenses would be a little low expense estimate. My understanding is it is better to use 45-50% total expenses.

depends on scale. But if you are looking for easy math and conservative estimates use 50%.

This is a rule of thumb that I like: Use 50% expense. 100% LTV Financing at 10% interest only. Does the property break even?

``````                      Cap Rate  - Capitalization Rate

The Capitalization Rate or Cap Rate is a ratio used to estimate the
value of income producing properties.  Put simply, the cap rate is the
net operating income divided by the sales price or value of a property
expressed as a percentage.  Investors, lenders and appraisers use the
cap rate to estimate the purchase price for different types of  income
producing properties.  A market cap rate is determined by evaluating
the financial data of similar properties which have recently sold in a
specific market.  It provides a more reliable estimate of value than a
market Gross Rent Multiplier since the cap rate calculation utilizes
more of a property's financial detail. The GRM calculation only
considers a property's selling price and gross rents. The Cap Rate
calculation incorporates a property's selling price, gross rents, non
rental income, vacancy amount and operating expenses thus providing
a more reliable estimate of value.

If we have a seller and an interested buyer for particular piece of
income property, the seller is trying to get the highest price for the
property or sell at the lowest cap rate possible.  The buyer is trying to
purchase the property at the lowest price possible which translates into
a higher cap rate.  The lower the selling price the higher the cap rate.
The higher the selling price, the lower the cap rate.  In summary, from
an investor's or buyer's perspective, the higher the cap rate, the better.

Investors expect a larger return when investing in high risk income
properties.  The Cap rate may vary in different areas of a city for many
reasons such as desirability of location, level of crime and general
condition of an area.  You would expect lower capitalization rates in
newer or more desirable areas of a city and higher cap rates in less
desirable areas to compensate for the added risk.  In a real estate
market where net operating incomes are increasing and cap rates are
declining over time for a given type of investment property such as
office buildings, values will be generally increasing.  If net operating
incomes are decreasing and capitalization rates are increasing over
time in a given market place, property values will be declining.

If you would like to find out what the cap rate is for a particular type of
property in a given market place, check with an appraiser or lender in
that area.  Be aware that the frequency of sales for commercial income
properties in a given market place may be low and reliable capitalization
rate data may not be available.  If you are able to obtain a market cap
rate from an appraiser or lender for the type of property you are
evaluating, check to see if the cap rate value was determined with
recent sales of comparable properties or if it was constructed.  When
adequate financial data is unavailable, appraisers may construct a cap
rate through analysis of its component parts thus reducing the credibility
of the results.  Cap rates which are determined by evaluating the recent
actions of buyers and sellers in a particular market place will produce
the best market value estimate for a property.

If you are able to obtain a market cap rate, you can then use this
information to estimate what similar income properties should sell for.
particular piece of property is over or under priced.

NOI                                                                   NOI
Cap Rate  =     --------                        Estimated Value  =    -------------
Value                                                              Cap Rate

Example 1:   A property has a NOI of \$155,000 and the asking price
is \$1,200,000.

\$155,000
Cap Rate =       --------------    X     100   =  12.9 rounded
\$1,200,000

Example 2:  A property has a NOI of \$120,000 and Cap Rates in the
area for this type of property average about 12%.

\$120,000
Estimated Market Value  =     ------------     =     \$1,000,000
.12

Net operating income is determined by subtracting vacancy amount and
operating expenses from a property's gross income.  Operating expenses
include the following items: advertising, insurance, maintenance, property
taxes, property management, repairs, supplies, utilities, etc.  Operating
expenses do not include the following items; Improvements such as a new
roof, personal property such as a lawn mower, mortgage payments,
income and capital gains taxes, loan origination fees, etc.

Appraisers use the Income Approach, Cost Replacement and Market
Comparison methods to estimate the value of property.  The Income
Approach utilizes the theory of Capitalization.
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