# Cap rate?

How do i figure out the Cap rate on a property?

Cap Rate = NOI/Value

NOI = Net Operating Income
Value = the price

Thanks that makes more sence now. So what do you all think a cap rate should be around before you make that investment…

It really varies from area to area and the level of risk and type of investment. For plexes in good areas, you can get 8-10% and for bad neighborhoods you may want 15% for it to be worth it. These percentages may work in Texas, but they may not be realistic in California for example.

Check around your city and see what the average cap rate is. You should find this information online or by asking an informed realtor. You may even find ads for plexes that has their cap rate posted.

Check for example loopnet.com

If you want to spend a bit of money you can get a report on cap rates for your metropolitan area. The two that I have used have been from loopnet.com and realtyrates.com.

They are compiled from reported deals (which tend to be relatively large) and also they are generaly up to 3 months behind the market.

They are never a substitute for getting to know your market (prices, rents, and neighbourhood trends for your prefered type of property).

I’m glad I found this. What is cap rate? Does CAP stand for something? I just bought a duplex and didn’t know anything about cap. I ran the numbers, did my due dilligence on the owner and property and bought it.

I’m also looking at a 8-plex right now. Purchase price is 262K. Rents are 3,340.00 per month. Do I take 3,340.00 divided by 262K and that’s my cap rate? I get .01 if I do it this way? Care to explain what I’m missing or doing wrong? Thanks folks,

Nate-WI

I’m new at this stuff, myself, and I’ve yet to even by my first property, but I believe the cap rate uses the NOI for the year. So, if the property brings in 3340 per month after all fixed and variable expenses, then:

3340 x 12 (months) = 40080
40080/262000 = 15.29%

I think. Like I said, I’m new to all this, too, so someone let me know if I got that right.

Howdy King:

The cap rate is figured using the net operating income which is the income minus the expenses. I do it even easier. If i can rent a house for \$500 I will pay \$25k more or less. This may not work in a lot of areas but it works for me. I am involved in a commercial rehab where the rents will be \$8K per month and I paid \$400K.

CAP stands for Captialization. So, the CAP rate is the Captialization Rate. Fadiz gave the correct formula above. Cap rate = NOI/estimated market value. Some “investors” use cap rate as a way determine the value of a property. However, I think that this approach is very misleading. We know that the vast majority of investors do not succeed. Approximately 80% of new businesses fail and real estate investors are certainly no exception (quite the opposite, I’d guess). Most of these failed investors paid way too much for their properties - thus the reason that they fail. Therefore, if you look at the average Cap Rate for an area, you’re really just getting the inflated prices paid by the failures in your area. The truly successful investors paid a LOT less than the value suggested by the average cap rate for the area.

NOI is found by determining the gross annual rents and subtracting all expenses EXCEPT mortgage (P & I). In the example given by The King, here’s how it might look:

Gross rents \$3340/mo = \$40,080/yr

Taxes - \$3,600/yr
Insurance - \$1,500/yr
Management Fee - \$4,000/yr
Vacancy Allowance - \$2,000/yr
Maintenance Allowance - \$4,800/yr
Utilities paid by Owner - \$1,500/yr
Misc - \$2,000 per year

Therefore NOI = \$20,680

Therefore Cap Rate - \$20,680/\$262,000 = .079 = 7.9%

This is all without considering the mortgage!!! A 30 year mortgage on \$262,000 at 8% is \$1,922/mo = \$23,069 per year. So, now let’s consider a cash flow analysis for this property:

Gross rents \$3340/mo = \$40,080/yr

Minus Expenses:

Taxes - \$3,600/yr
Insurance - \$1,500/yr
Management Fee - \$4,000/yr
Vacancy Allowance - \$2,000/yr
Maintenance Allowance - \$4,800/yr
Utilities paid by Owner - \$1,500/yr
Misc - \$2,000 per year
Mortgage Payment - \$23,069

Total Expenses = \$42,469

So, in the end you’re actually LOSING \$2,389 per year on this property IF YOU’RE LUCKY!!! These expenses don’t allow for capital improvements, damage caused by tenants, evictions, lawsuits, exterminations, etc. I did include in a \$2,000 miscellaneous expense, but even one of these things could easily use all of that.

This is the reality of real estate investing. As you can see, an 8% cap rate can easily be a loss in the real world.

Good Luck,

Mike

Where’d you pull all those numbers from? Wouldn’t they vary from state to state or, possibly, even county to county?

Howdy Mike;

Wow what a response. You should teach this stuff. You really took some time to type it etc. Great explanation.

I too agree with you about over inflated prices. You may recall back in the 70’s and early 80’s cap rates were not as important as how much income could be sheltered by an investment. Prices were so high that negative cap rates were seen.

The King,

The expense numbers are pretty close for most areas of the country. They certainly would vary a little from one area to the next. However, the point of the post wasn’t guessing about expense numbers. The point of my post was that cap rate is just about useless in determining the actual “value” of a property. What is important with rentals is doing an accurate cash flow analysis for each property including ALL real world expenses and then basing your purchase price on that. In this example, an 8% cap rate actually resulted in a loss of nearly \$200 per month. I don’t know about you, but I’m not interested in owning too many losing investments.

Mike

Thanks for the responses folks. There are alot of rentals in my area where I can get them at 85 cents on the dollar. I guess my thinking is why not buy a property with nothing out of my pocket and cash flow 200 bucks minimum with a property this has equity and is in good shape with very little repairs needed? Cashflow is great and will lead me to quit my job when I have enough money coming in. Not to be overlooked are expenses but to me its just part of the game. Sure I can figure them in and I will do that cause it will give me a good idea if I’m getting a solid property or not. But…I may have nothing go wrong one year and the next the place is breaking down in front of my eyes.

Another thing that I’m learning is that rents are meant to be raised. The property I’m looking at on this 8-plex the average rents are 417.00 per unit. It won’t be that way very long as this rental is in a solid area and the rents are about 25 bucks on the light side. I may lose some tenants when they come to renew but oh well. I will fill them quickly at a higher rate and cashflow even more. Just by raising them only 20 bucks a unit that’s an extra 160 bucks a month.

Also it depends on how much am I going to do or contract out. I can save money there. Also all tenants pay their utilities in this propety. Again these are points that I want to make to add to the conversation. I’m new to this but I wanted to add some more to the discussion. I hope I didn’t step on your toes. If so…well suck it up

Nate-WI

So i guess it’s safe to say that if they just list the price and cap rate you can do the old math and plug in the numbers to find the missing one…

So for the sake of scenario, i am looking in the San Diego Union Tribune - Sunday paper and under the income property section it has listed:
“Just Listed!: 6% CAP (Name of units); 8 units-Mostly 3 br/2 ba” then it lists the number to call…

Would you rather have a high cap or a low one? Why?

Another listing states “6 tenant showroom, \$4M, 6.7% CAP”

Can someone break that down for me…?

I guess at this point you’d call the number and ask for a proforma so you can analyze this for yourself, correct?

Thanks…

Wow, when the cap rates are in the 6 or 7 range, the only way you’re going to make money is through price appreciation, you’re not making it on the cash flow.

Also in that previous analysis, one key item was left out which was the depreciation deduction. You can only depreciate the improvement to the land so if 62k represented the land and the house was 200k, you would have a 7,272 deducation at tax time. If you’re in the 28% bracket, you’d save \$2036 on your taxes.

And of course all those other expenses such as interest and maintenace are also tax deductable. So in the real world, you’d miss about \$2k in cash out of your pocket, but at tax time, you’d get a few thousand back.

SD Newbie,

You are correct, you can do the math and find the missing number. In your example: “6 tenant showroom, \$4M, 6.7% CAP”, NOI = Cap Rate X Market Value. Therefore, to find the NOI IF, IF, IF the market value were \$4m, you would multiply .067 by \$4,000,000 to get a NOI of \$268,000. Then to get an idea of your cash flow, subtract the mortgage payment on \$4M, which would be about \$352,000 per year and you can see that this wonderful property would LOSE at least \$84,000 per year. Not my idea of a good investment.

A higher cap rate is better than a low cap rate. However, remember that the cap rate is based on what the seller claims as income and expenses. You might be surprised at how optimistic the seller can be when they give you a cap rate.

I completely ignore the cap rate and run my own cash flow analysis on any property that I am considering buying.

Mike

Amen to that, I have never yet found a listing that the actual numbers actually matches the advertised Cap Rate. Dig deep and do your own analysis, or at least make your offer a cap rate offer, then the price adjusts as you learn the real numbers.

DB