Back in the bad old days circa 2005-06 I remember looking at some duplex units with an investor client of mine and him asking me whether I thought these were "Good Deals" or not. Putting pencil to paper I did some quick math and came up with an average "Cap Rate” of around 4…meaning the prices on these properties at the time just did make any financial sense even though at the time they were being snapped up as if they did. When looking at duplexes priced at nearly $500,000 and the NOI being around $20,000 I told my client to hold off and wait to see what happens next. One of my few great calls during the run-up!
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The same investor contacted me last spring and we started looking into multi-family properties again. This time all was very different. The first property the investor acquired was a bank owned tri-plex in the heart of rental heaven at Lake Tahoe…near the casinos, skiing and beaches meaning a majority of the employment base would be in the market for his commodity. The property needed extensive work however but after running the numbers and figuring in some over-runs the project went forward. Initially the purchase price was $125,000 and after the renovation the capital outlay was around $205,000. The NOI after full occupancy ended up being $21,000 and a Cap Rate of 10.25!! Now we were cooking with gas.
The search continues for properties with cap rates higher than about 10 in order to make sense for this particular investor. It is interesting to note that there are still sellers…banks included….that have no idea what an investment property is worth or should be worth in this particular market.
Cap Rate = _______________Estimated Market Value = ___________________
Market Value Cap Rate
Example 1: A property has a NOI of $126,000 and the asking price is $1,200,000.
Cap Rate = _____________ X 100 = 10.5
Example 2: A property has a NOI of $120,000 and Cap Rates in the area for this type of property average about 10.
Estimated Market Value = __________________ = $1,200,000
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.
Note about Cap Rates:
Simplified, the CAP rate is the NOI divided by the purchase price, expressed as a percentage. Buyers will look for higher CAP rates indicating a higher return on their investment. Sellers will of course look to sell at a higher price, resulting in a lower CAP rate since the NOI is relatively fixed and determined by the rental market.
Cap Rate Calculator
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