Question: Exact Numbers to Include in Cap Rate

2 Replies

I have been reading through some previous discussions regarding how to calculate Cap Rate. To me, there seems to be differing and contradictory information with what numbers to include when calculating Cap Rate.

Let me explain, my initial question was how to calculate Cap Rate. I now understand that:

Cap Rate = [annual] NOI / Purchase Price [some use value]

I also understand that NOI is your income minus expenses DOES NOT ACCOUNT FOR MORTGAGE COST.

Which leads me to this, what exactly do you include in the purchase price - is it strictly what you paid for the property should you include other costs?

Ex. If I purchase a property for $100,000 but have to put $10,000 into renovating it, in calculating my cap rate, do I use $100,000 or $110,000 because it's a more accurate number?

Furthermore, in considering NOI, do you use what it currently rents out for (or a comp if it's not rented out), or would you use a figure representative of what you assume to get for rent after renovations? (educated assumption based on comps in the area or provided by Realtor).

Ex. The property that I purchased for $100,000 currently rents out for $1000/month, AFTER putting $10,000 worth of renovations into it, based on educated assumption, I can expect to get at least $1,200/month. WHAT FIGURES DO I USE IN THIS SCENARIO WHEN CALCULATING MY CAP RATE?

Lastly, I read in one of the forums that if you are using an all cash purchase then your Cap Rate and Cash-on-Cash Return would be the same - if you consider your total investment in COC then they wouldn't be the same if you don't figure renovation costs when calculating your Cap Rate.

Below, is a purchase scenario - can someone please work through the Cap Rate and COC Return to demonstrate to me how this all comes together?

Ex. ALL CASH PURCHASE 

Purchase Price: $100,000

Estimated Closing Cost: $4,000

Estimated Renovations (needed to rent it out): $10,000

Taxes: $2,000

HOA: $200

Current Rent: $1,000

Expected Rent (after renovations): $1,200

If I missed anything else just plug in a fake number to show me, this is fictional scenario.

Thank you - Please help!

I'm not an expert. I include closing and rehab cost in my calculation. But I don't find CAP rate useful since I plan to finance my purchases. I calculate COC, Return On Investment, and sometimes Return On Equity. Sounds like CAP rate is just unlevered ROI.

@Brianna H.

Cap rate is the rate of a return an investment in an asset will realize assuming the asset is purchased all cash. This makes sense because the formula for the cap rate = NOI/Price.

Cap rate is used more of a market indicator - for instance, if all comparable buildings in your area are trading at a 7% cap, then your building will likely trade at a 7% cap. It's an indicator of what the market is currently willing to pay for a particular asset.

It should also be noted that cap rates only really apply to commercial buildings and apartment complexes.

For your scenario:

Purchase Price: $100,000

Current Rent: $1,000

*My assumed expense ratio: 45%

Monthly NOI: $550

Annual NOI: $6,600

Purchase Cap Rate: 6.6% ($6,600/$100k)

Expected Rent (after renovations): $1,200

*My assumed expense ratio: 45%

Monthly NOI: $660

Annual NOI: $7,920

Post-reno price: $120,000 ($7,920/.066) - You generally divide new rents by the market cap or purchase price cap

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