Real Estate Related

The number one topic that always drew the most questions during my presentations of NAR’s Fundamentals of Commercial Real Estate course was always “Cap Rates”.  Cap Rate or capitalization rate is a simple calculation and is easy to compute. If you know the net operating income of the investment property you can calculate market value from the Cap-Rate. Here is the formula:

Market Value = Operating Income x 100 / Cap Rate (%) or  MV = NOI x 100 / Cap Rate (%)

As an example $50,000 NOI divided by a .095 (9.5%), Cap Rate = $526,316 market value, easy right, the problem is where do you get the Cap Rate value?

That is where this simple rule of thumb gets complicated, the Cap Rate value is actually a measure of risk. A low risk investment like a 20 year leased Walgreen Store property might have a cap rate of 7% or lower, while a 100 year old tenement building with a high vacancy rate, deferred maintenance and located in a depressed city or town could have a cap rate of 13%, 14% or higher. As with any investment, risk determines the price investors are willing to pay. With real estate the location, quality of the leases, credit worthiness of the tenant, age and condition along with the economic status of the market and many other factors influence the amount of risk in ownership of the property. Generally cap rates for a given property can be derived by researching comparable property sales in similar condition located in the same market. Adjusting the cap rate for qualitative or quantitative differences in the properties can zero in on market value cap rates. Keep in mind it is only a rule of thumb to be used in the comparison of potential properties. Due diligence requires considering other investment metrics which we will discuss in future blogs.

This entry was posted on Monday, August 17th, 2009 at 7:12 pm and is filed under Investment. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.