CAP
Hello,
Please explain to me in the plain English what is CAP means?
This is our property. We bought it for 65,000, put 30,000 in rehab. It can be rented for 1,300 per month (duplex). Market price is about 140,000. Montly expenses are 400.
How do I calculate the CAP? Why is it needed?
I really would like to know because we are looking into another place to purchase and lady was talking about 10% CAP.
Thank you for your time,
Yulia
CAP Rate is a ratio used to estimate the income-producing potential of a property.
Cap Rate=NOI/Value
where NOI (Net Operating Income) is:
NOI= Annual Gross Income - Annual Total Expenses
Total Expenses includes: Property taxes, Vacancy Allowance and Operating Expenses (Insurance, Uitilities, trash, landscaping, etc,etc)
Annual Gross Income: is the income expected as is all the units were rented year round.
As an example, let's calculate the Cap Rate of your property.
Annual Gross Income: $1,300*12=$15,600
Annual Total Expenses: $400*12=$4,800 (assuming that number reflects ALL the expenses)
NOI = $15,600 - $ 4,800 = $10,800
Cap Rate= 10,800/140,000=0.0771
if you want it as percentage (the most common way) multiply the result by 100
Cap Rate= 7.71% not bad, but as you could guess, 10% is better.
Hope that helps,
Roger.
One quick correction. He only has 95k into the property, so the cap rate on his current deal is 11.3% .
[addsig]
Don't confuse "Cap Rate" with "Rate of Return", they are two different figures.
"Cap Rate" does not depend on the amount invested, "Rate of Return" does.
Roger.
Thank you so much!
That explained many things.
And I guess I need to look for 10% CAP.
What would be less acceptable CAP?
Yulia
The Cap Rate is not the only ratio to look for. There's also the Rate of Return.
The first will give you an idea of the income-producing potencial of the property. The second gives you the actual return (like interest in a bank) for your money.
Two different propertites of the same value and the same Cap Rate, won't have the same Rate of Return (also known as Return on Inventment, ROI) if one of them requires mayor repairs to begin with.
That's because you have to invest more money to get the same amount of money every month. With this, I'm assuming that the Cash Flow in both properties is about the same.
Roger.
This will probably fall upon deaf ears. But,when most small income investors (1-4 units), most residential Realtors,and most residential appraisers talk Cap Rate you should immediately think ----CRAP Rate.
It takes skill, experience,and training to correclty process the income stream and developpe a Cap rate for these types of properties. The Cap rate is essential for Commercial properties but that's a different story and a different post.
You will be on much more secure just doing a good search for comps and doing a good Market analysis.
Roger,
For a property you already own, the CAP rate calculation would use your initial cost basis (purchase price plus capital improvements) for the Value of the property not the current FMV.
For a property you already own, the ROI calculation would use your actual out of pocket costs and your CASH FLOW (not NOI). For a property that you purchased for all cash and own free and clear, the CAP rate and the ROI would be equal because your NOI is your cash flow and your purchase price is your initial out of pocket cost.
For the rest of us who use financing to purchase our property, we have debt service to pay which does not change the NOI but does reduce the cash flow. On the other hand, because we used financing, we have a lower initial out of pocket expense (down payment and closing costs instead of the full purchase price) to use for the ROI calculation.
For a single family residence, a cap rate calculation is meaningless because the Value of the property is established by comparable sales. If you insist upon a CAP rate calculation anyway for a property you are seeking to purchase with tenants already in place, you would
use your required CAP rate and the property NOI to determine the value of the property to you. A 10% CAP rate suggests an average property, while a higher number suggests a property in trouble (perhaps declining area, deferred maintenance, etc.). If the CAP rate number is 14% or higher, I am expecting a war zone. A CAP rate number lower than 10% means the seller has placed a high value on the property. If the number is 8% or lower, I would expect this to be a great property in a super location with tremendous potential for appreciation. The higher the price, the lower the CAP rate and vice versa.
Hope this clears the waters for everyone.
10% CAP is average? Are there residential deals out there with CAP rates of 10%? Where? I'm new at this, but I'm evaluating deals, and I cant find any deals with CAP rates higher than 5% (and that's not including ALL expenses).
If I can get 10% return (on a cash deal) on my money, where do I sign??
thanks for any help.
-J
this is not a tool I have used but for quick looks it could help...I take it this does not consider any payment of any mortgages...
Dave,
Everywhere I've looked, the Cap Rate calculation involve the Market Price, no matter if you already own the property or not.
Yulia,
If the Cap Rate is usefull or not, is a matter of another discussion. You asked what it was and I hope you got the idea
Roger. [ Edited by Rangui on Date 01/14/2004 ]
Quote:Everywhere I've looked, the Cap Rate calculation involve the Market Price, no matter if you already own the property or not.Roger,
You are correct, the definition I have calls for Purchase Price. Once you have purchased the property, your purchase price does not change.
CAP rate calculations are meant to be used to determine the potential value of a property for which comparable sales numbers do not exist. The calculation is most meaningful for commercial investment property. For example, a 24 unit apartment building is on the market. How do you determine a fair value for the property when there are no comparable sales numbers to go by.
One answer is a CAP rate calculation. If you know (or can determine) what Net Operating Income the property generates, then you divide the NOI by your required CAP rate to determine your opinion of the market value for the property. The seller may have a different opinion, but your estimate is all that matters.
Fair Market Value is the price that an interested but not desperate buyer would be willing to pay and an interested but not desperate seller would be willing to accept on the open market assuming a reasonable period of time for an agreement to arise.
You can not really know what the FMV of a property is until you actually sell it. You can try to estimate the FMV of a property with comparable sales numbers, or -- for commercial property -- with a CAP rate calculation.[ Edited by DaveT on Date 01/15/2004 ]
Quote:10% CAP is average? Are there residential deals out there with CAP rates of 10%? Where? I'm new at this, but I'm evaluating deals, and I cant find any deals with CAP rates higher than 5% (and that's not including ALL expenses).JonDoe,
I am told that Real Estate Appraisal, 11th Edition states that the average CAP rate for all buildings in America is 10.14%. I assume that the reference is to commercial properties only, because a CAP rate calculation is really meaningless for 1 to 4 family residential properties.
For 1 to 4 family residential properties, the value of the property will be established by comparable sales numbers. That is why you ask your realtor for the "comps" and not for the CAP rate for a potential investment rental property.
From the comps, you have to do a cash flow analysis to determine if the property fits your acquisition criteria. Most of the time, a CAP rate calculation for my rental property purchases is about 7%. Because this number is really meaningless for a 1 to 4 family rental property, I use Debt Coverage Ratio and Internal Rate of Return calculations as my discriminating criteria. If the DCR is at least 1.25 and the IRR is at least 15%, the property passes my screening and deserves serious consideration.
thanks for reply DaveT.
I'm now understadning what CAP is and what it's for. However, from my POV, even for 1-4-family units, if you use comps to determine price, then calc CAP using price as an input, it seems to be a very useful basis for comparison.
Debt Coverage Ratio seems to essentially be the same as CAP but with your financing flows factored in.
What inputs do you use for calc'ing your IRR? Do you assume some cap appreciation as an input? Do you discount your flows using a term structured or just a flat rate? Just curious.
CAP Rate calculations are based upon the purchase price and the NOI. DCR tells me if the NOI is good enough to support the property. If I put more money down to lower my debt service, my DCR goes up while the CAP rate stays the same. DCR callculations are also interest sensitive. If the interest rate is high, then so is my debt service, which means that I either have to purchase at a lower price or put more money down to achieve a DCR of 1.25 or better.
IRR, by definition, is the discount rate at which the net present value is equal to zero. For my calculations I use my initial out of pocket costs (downpayment, closing costs, repairs), my annual after tax cash flows, and the after tax sale profit after an eight year holding period. For price appreciation, I assume 5% annually.