Real Estate Deal Metrics:

As an investor, how do I calculate the capitalization rate?

//Thread with numbers and calculations//

Let's say we own 10 units and they rent for $1,000/month each.

Every year, we generate $120,000 in income (gross rents possible).

We assume that we need to account for vacancy which is at 5%.

$120,000 in income * 5% = $6,000

This $6,000 is subtracted and put into a bank account for any future vacant units (reserve account).

For the year, our effective gross income is $120,000 - $6,000

$112,000

Let's assume in total it costs $65,000 per year to operate.

This will include repairs & maintenance, utilities, insurance, property tax, property management, and capex reserves.

Net operating income is our total income generated after accounting for vacancy - operating expenses

$112,000 - $65,000 = $47,000 in net operating income.

For this building, I have paid $800,000.

What is my capitalization rate?

Cap rate = net operating income / market value (or price paid)

= $47,000 / $800,000 = 5.9%

This is the return I can expect if I paid all cash for the deal.

A capitalization rate is another way of saying "unlevered return" since no debt is used to acquire this asset.