The “cap rate” is used by informed real estate investors to estimate the value of an income producing property. It shows the productivity of an income producing property.
How Calculated: The cap rate is the relationship between Net Operating Income and the value of the income producing property. The Net Operating Income of recently sold income property is compared to their sale price.
Components: 1. The Net Operating Income is the amount of cash that a property is capable of generating annually if owned free and clear of debt, and before income tax payments. 2. The sale price is the price paid by an informed investor for the right to receive that amount of Net Operating Income in the future.
Calculation: Divided the Net Operating Income by the sale price. The resulting number is the “cap” or “capitalization” rate.
How Used: Knowing the applicable cap rate for the type of property to be acquired, an informed investor can then divide the Net Operating Income of the property being evaluated to determine a reasonable investment value of that property.
What You Need To Know About Cap Rates:
1. Cap rates vary with each type of income property will usually have a unique and similar cap rate (apartment complexes vs office buildings vs medical buildings vs retail buildings – each property type will have a different cap rate)
2. Cap rates vary with each market and submarket. The cap rate for an apartment complex in Seattle will vary from the cap rate of a very similar apartment complex in San Francisco or Eugene, Oregon. The perceived risk inherent in each market and each submarket will influence the cap rate of highly similar property types.
3. If you carefully study the typical commercial real estate transaction, you will find that the seller is trying to sell for the highest price (which will produce a low cap rate); and, the buyer is trying to buy the property at the lowest price (which translates into a higher cap rate for the available income stream). For the same income stream to the investor, the lower the sales price, the higher will be the cap rate.
4. Market cap rates can vary with the level of motivation of the seller and the eagerness of the buyer.
Where Can I Find a Reasonable Cap Rate:
1. Call a local real estate appraiser who is very experienced in appraising the type of income property that you seek to buy or sell. Ask for a range of reasonable cap rates for that specific type of property.
2. Call a real estate investment broker who is dominant in the market area which interest you, and who is most experienced with brokering transactions for your specific type of property. Email or call me (541) 912-6583 for further recommendations.
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