Things You'll Need:
- Access to Information regarding investment properties sold in the past year
- Financial statement for all properties considered, including net operating income
- Calculator
- Knowledge of desired rate of return on investment
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Step 1
Determine the rate of return you desire. This will be affected by market conditions, prime rate and yields. If your Money Market account is producing an average of 10 percent, you will want your investment to do better, or you can just leave the money in the Money Market and not have to do anything for the added income.
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Step 2
Study the financial statement of the investment property. Let's assume you are looking at investing in an apartment building. Find the net operating income of the apartments. The Net Operating Income (NOI) is determined by deducting operating expenses from effective gross income. Make sure that they have included all fixed, variable and reserve expenses from the effective gross income, as sometimes the reserves are left out.
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Step 3
Determine if the property is a good rate of return. Since the Capitalization Rate does not take into consideration debt service, we will assume you are paying cash for your investment. The price of the apartment building is $100,000, and you have learned from the financial statement that the net operating income is $10,000. Divide the $10,000 (NOI) by the $100,000, and the rate of return is 10 percent. Before you know if this is a good rate of return or not you will need to do the same procedure on other investment properties that have sold within the past year.
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Step 4
Figure a good capitalization rate. Let's assume the investment properties you have found average the 10 percent rate of return, but due to increases in costs this year, you want a rate of 12 percent. Divide the NOI--in this case, $10,000--by .12. That equals $83,300, which would be the most you would be willing to pay for the apartment building to receive your desired rate of return.
