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Cap Rate -
Capitalization Rate |
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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. |
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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. This will help you to gauge whether or not the asking
price for a particular piece of property is over or under priced. |
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| NOI NOI |
| Cap Rate =
------------------
Estimated Market Value = -------------- |
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Market
Value
Cap Rate |
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Example 1: A property has a NOI of $155,000 and the asking price
is $1,200,000. |
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$155,000 |
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Cap Rate = --------------
X 100 = 12.9 rounded |
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$1,200,000 |
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Example
2: A property has a NOI of $120,000 and Cap Rates in the area for this
type of |
| property average about 12%. |
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$120,000 |
| Estimated Market Value = --------------
= $1,000,000 |
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.12 |
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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.
The On Target Real Estate Investment Software calculates the Cap
Rate for an income producing property as you enter the property
data. You can run "what if" scenarios changing the sales
price, rental income, vacancy rate and operating expense amounts and
the cap rate is automatically recalculated. No need to use a
calculator to run different scenarios. The ratio analysis
report summarizes the cap rate data over a ten year period based on
your input data and assumptions.
(c) Copyright 2000 - 2008 Advantage Software LLC
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