How Did You Calculate Your Cap Rate? LOL!!!

Greetings from the metropolis of Cedar Crest, NM!

It has been a while since I have personally posted on www.TheRealWealthBlog.com. I have been going through a funk of sorts and trying to figure out what direction to go. I have been a commercial real estate coach for a while and thinking it is time to go on my own….but not really sure how to do that.  So….as I try to figure it out…let me tell you about Capitalization rates (CAP Rate)….Yawn…

Why CAP rates? Well….after going through this last deal (500 unit apartment complex in Texas that went down the tubes), sellers, buyers…brokers and agents have their own definition of a cap rate. SO….I thought I would set the record straight….or possibly screw it up even more. To explain Capitalization Rates, Emily Cressey, with the use of a white board, gives a great visual of the definition of a Cap Rate.

Before I begin on setting the record straight, I do want to let you know that my next post will be on how I put together the deal than was not to be. I will show you the contract, the analysis, the third party firms I used, even how that dadgum deal blew up.  It was actually a great learning experience….again.  I hope you will get a lot out of my experience.  That is what we are here for.

Anyway…..

Capitalization Rate (CAP Rate)

Cap Rate: “Cap rate” means “Capitalization Rate” – it is actually a percentage rate of return that you would get from the INCOME of the property if you were to buy it ALL CASH with no leverage.

Here’s the formula: Cap Rate = NOI/Price

For example, if you bought a million dollar building with no loan and the NOI was $80,000 a year, that building would be an “8-cap” (Cap Rate = $80,000 / $1 Million = 8%)

If the same building had an NOI of $90,000, it would have a 9-cap as its capitalization rate.

Understanding the formula behind the terminology makes things a lot easier to understand.

***One key thing to remember is when the seller/agent/broker gives you the financials of a property and tell you what the Cap Rate is, find out how they calculated the Cap Rate.  Do your own math.  Sellers/agents/brokers tend to play with the expenses and tend to remove some expenses into capital expenses which tend to boost the NOI of the property.  Catagories such as maintenance, reserves, property management, etc., tend to “sneak” out of general expenses giving you a false NOI.

Emily’s video explaining Capitalization Rate