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Real estate deal check:
What are capitalization rates?
Let's discuss.
What are capitalization rates?
Let's discuss.
As investors, we buy property because it is an income-producing asset.
Some of the benefits:
1) Cash flow
2) Equity
3) Appreciation
4) Tax deductions
5) Effective use of leverage
etc.
Some of the benefits:
1) Cash flow
2) Equity
3) Appreciation
4) Tax deductions
5) Effective use of leverage
etc.
No matter who you talk to about real estate, in some shape or form, capitalization (cap) rates will come into the conversation.
What even is a cap rate?
What even is a cap rate?
Before we get started, if you are buying property, you are focusing on "net operating income (NOI)" and how much of it the property generates.
Property NOI is the potential gross income minus allowance for vacancies and then subtract operating expenses.
Property NOI is the potential gross income minus allowance for vacancies and then subtract operating expenses.
This does not include capital expenditures or debt service (the loan on the property).
Think of NOI as a number that measures the amount of income expected to be available to be divided between debt and equity investors.
I.e., how much NOI do I have to pay returns?
Think of NOI as a number that measures the amount of income expected to be available to be divided between debt and equity investors.
I.e., how much NOI do I have to pay returns?
Before you pay off equity investors (yourself or a group of investors), you have to pay off the lenders which is why this is separated from property operations.
So, what is a cap rate?
A cap rate can be used to value a property - it is a static look at one point in time where you can estimate the value of the income stream.
You are trying to convert an estimate of a single year's income (NOI) into what the property could be worth.
A cap rate can be used to value a property - it is a static look at one point in time where you can estimate the value of the income stream.
You are trying to convert an estimate of a single year's income (NOI) into what the property could be worth.
Estimated property value = net operating income / capitalization rate
If the average cap rate is 10%, and the property generates $100K in NOI, then the estimated value is:
$1,000,000
If the average cap rate is 10%, and the property generates $100K in NOI, then the estimated value is:
$1,000,000
What does this mean?
Really, it is the return you would get if you paid call cash for the property.
Really, it is the return you would get if you paid call cash for the property.
To estimate an appropriate cap rate, it is critical to obtain verified cap rates for your specific property type and location.
Most commonly, cap rates for a property are derived from comparable properties sold (hopefully recently).
Most commonly, cap rates for a property are derived from comparable properties sold (hopefully recently).
Quick note - these are useful in the multifamily space where most of the properties are trading between investors.
If you are investing in single-family homes, the cap rates will fluctuate widely - even if you are on the same street, finding an average will be difficult.
If you are investing in single-family homes, the cap rates will fluctuate widely - even if you are on the same street, finding an average will be difficult.
I hope this thread helps!
REM
REM
