Doing the math: Cap Rate

This bang-for-your-buck yet simple calculation resulting in a percentage makes up one small part of your overall financial analysis, but tells you big information you can take to the bank. Here we show you what it is, when to use it, what is optimal, & how to calculate it.

Defined: Cap Rate is a ratio between the net income of the property and its original price (or “capital cost”)

Key 1: When you think CAP RATE, think rate of return when:

· Determining the maximum amount that an investor should spend given the annual

return that investor plans to make (i.e. For current property)

· Comparing similar properties (i.e. Tax Deferred 1031 Exhange)

· Comparing properties that have different net income and purchase prices (i.e. Choosing a

new acquisition)

Key 2: When calculating Cap Rate, first you need the following ingredients in your formula:

· Calculate the net income of the property

· Calculate the expenses of the property

Key 3: The “ideal” Cap Rate varies, but mobile home park investors today are aiming for:

8% to 11%

Math Workout:

Equation: CAP Rate = Annual NOI / Cost or Value

Example 1: You, the investor, want to know the max asking price you should pay for a property . You would like to generate $10K of net income in year 1 with a cap rate of 10%:

Step 1: 10 = 10,000/Value

Step 2: 10,000 x 10 = 100,000

Max Price: $100,000

Example 2: You want to do a 1031 exchange. You don’t have the financials yet but You know the property is valued at $400,000, current rental income is $4,500 per month ($49,920 per year), there is a 6% property management fee, $4,000 in taxes, $600 for insurance and $3,000 for maintenance. Plus, you are aiming for a 10% cap rate.

Gross Income $49,920

(Prop. Mgt. Fee) (2,851)

(Maintenance) (3,000)

(Taxes) (4,000)

(Insurance) (600)

Net Income 43,549

Purchase Price 400,000

CAP RATE 9.86%

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