How Do You Figure Cap Rate?
How do you figure Cap Rate? And then what do you do with it? Some one just said on another post that I need to buy my rental for no more than 6 times gross annual rent. I am putting a contract on one tomorrow that isn't close to that but still cash flows well.
Annual rent: 23,400
purchase price: 225,000
That's about 9.6 times annual rent. Is that okay? Is that a 9.6% Cap rate?
Thanks
Josh
[addsig]
Cap Rate = (Net Operating Income) / (Property Value)
Gross Rent Multiplier = (Property Value) / (Annual Gross Rents)
Cap Rate calculations are usually done for commercial investment grade property where comparable sales numbers do not exist. It is a method of determining the value of a property you may wish to purchase. For example, if you know that the annual Net Operating Income for an 8-unit apartment building is $24K and if your required cap rate is 10%, then its value to you is $240K or less. For properties with four or fewer units, a cap rate calculation is meaningless since comparable sales will be used to determine market value.
If that same property has gross schedule rents of $36K and the seller is asking $240K, your Gross Rent Multiplier (GRM) is 6.6. If the GRM for similar properties in the area is also 6.6, then you might say that this property is fairly valued. On the other hand, if the GRM for similar properties in the area is 8.0, then you might think you are looking at a bargain. GRM is just a quick and dirty rule of thumb for estimating the value of a property. It does not replace a detailed cash flow analysis.