![]() That ends our commercial real estate investing crash course.ĬLICK here to subscribe to our mailing list and get unique, fresh content like this delivered right to your inbox. This is very close to the annual cash flow I calculated above. In this example, since I’m borrowing money at 12% interest, any increase in cap rate above 12% means that that percentage of the purchase price goes right into my pocket. If you continue to play with the numbers, you can see why there can be such a great difference in a cap rate of 10% and a cap rate of 15%. This is an annual ROI of 55.5% (Notice that if you can structure a no money down deal, your ROI is infinity… In this case, I’m making a down payment of $7,500, and receiving $4,160 a year. This is the amount of money I’m getting for my out-of-pocket expense. One final useful calculation is the actual ROI or return on investment (I usually call it cash-on-cash). To complete the above example, if I borrow $82,500 at 12% interest for 20 years (this is the actual amount I’m borrowing, but I’m still not sure what the rate and term will be because I’m assuming a loan that was originally made for 3 properties, and it’s currently being restructured, so I’ve used this high rate and short term as a conservative estimate), we get:Ĭash Flow: $15,056 – $10,896 = $4,160 ($347/month). With single-family homes, emotion enters the equation and you need to pull comps of past sales. Note that this type of appraisal only works with commercial or multi-unit apartments. So if the property I just bought was in a place with an average cap rate of 15%, then the market value would be $15,056/.15 = $100,000. NOI is arrived at by subtracting the total operating expense amount from the effective gross income amount of a given property. It accounts for the cash flow of the property. In a well established neighborhood with high demand, you’ll probably be hard pressed to find a cap rate above 10% (which leaves a very thin spread when you borrow money at 8-10%).īy taking the average cap rate for a particular area, you can quickly determine the market value of a commercial property (NOI/cap rate = value). Net Operating Income (NOI) is a calculation used to determine the profitability of commercial real estate investments. What you typically find is that in any one particular market, the cap rate doesn’t change a whole lot. Basically, anything that has a cap rate in the teens is a good deal. The reason you can tell this is a good deal is because I can borrow most of this money at a substantially lower rate (8-10%). In this case, if I took $90,000 of my own money and bought this property, then every year I would receive $15,056, which is a yield of 16.7%. I know I’m in the ballpark on expenses if it’s between 40-50% of gross income.Ĭap rate stands for “capitalization rate,” and it’s basically the yield on your investment if you bought a property with all cash. ![]() Total Expenses: $11,364 (43% of Gross Income) ![]() Here’s an example of one of the properties I’m currently in the process of buying: Net Operating Income (NOI) = Gross Income – all expenses except debt service Gross Income = Gross Rent – vacancy factor + other income (for example, laundry) Gross Rent = Yearly gross rental income from all units
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