How to Figure Cap Rates

When talking about real estate investments, the term cap rates or capitalization rates may come up. If you want to figure cap rates, you'll have to understand the somewhat complex nature of real estate investments. Investors, lenders and appraisers all use the cap rates to make an estimate of the purchase price for the different types of income producing properties. Please read below to figure out how to determine the cap rates of a property.

Difficulty:

Moderate

Instructions

1. First, you have to figure the Net Operating Income (NOI) of the property. To figure the Net Operating income, you have to have to subtract the vacancy amount and operating expenses from the property's gross income. Examples of operating expenses include advertising, property taxes, repairs, supplies, utilities, and maintenance, etc. It does not include improvements or personal property, as well as capital or income tax gains.

2. The next step in determining the Cap Rate is to figure the market value. This is synonymous to the Asking Price for the property.

3. The cap rate is determined by dividing the Market Value into the Net Operating Income. (Cap rate = NOI / Market Value). If you wanted to figure the estimated market value, and you had the NOI and the Cap Rate already, the equation would look like this: (Estimated Market Value = NOI / Cap Rate).

Tips & Warnings

• Note that cap rates will vary for similar properties located in different areas of a city for a number of reasons, including desirability, crime levels, and the conditions in the area.

• Another way to figure and explain cap rates is that if net operating incomes are going down, and cap rates are increasing, that means the property values are declining.