What’s an easy formula to determine cap rates for the novice investor and why is it important?
To extract a cap rate from a market you’d find comparable properties and fill in the following equation:
NOI/ Value (Sale price)= Cap Rate
It’s a percentage applied to the NOI to determine an acceptable rate of return and recapture of the initial investment, determined by the market.
CAP rate is Capitalization Rate. It is a valuable term used for determining the true value of a commercial property. Remember 5 units or more is COMMERCIAL.
NOI = Net Operating Income / Sale Price = CAP Rate
When you buy, you want a high CAP Rate, and you want a LOW CAP RATE when you sell.
If you are a newbie, probably don’t want to be messing in these areas in all honesty just yet. Get some deals under your belt. Feel this out, see if it is for you. Do some residential properties. Get some experience first. That is just my humble opinion.
As mentioned the capitalization rate is a very important factor in the valuation of commercial real estate. Think of it as a discount rate that equates the cash flows (net operating income) generated by a property to the market value (sale price) of the property. The cap rate is determined by the marketplace and economic factors. Just as the formula NOI/Sale Price will give you the cap rate of a particular property using the alternate formula NOI/Cap Rate will give you a good estimate of the value of a property.