Calculating NOI to arrive at Cap Rate

[Brad Simmons]

I'm reviewing the tax returns of the seller of a 32 unit C class property. Below are screenshots of the returns.

So to get NOI from this information, I should subtract Depreciation and Interest to get the actual expenses, correct?

Where do I find CAPEX on the tax returns? That should be added back in to determine NOI as well, correct?

Lindahl says Cap rate on a Class C property should be 10-11, so buying it at a lower Cap Rate is good, right?

I realize these aren't all the questions I need to know the answers to, but these are my first ones.

[Jeff Copeland]

Do not include debt service when calculating NOI.

Though I would not necessarily trust calculations based solely on a tax return - I would prefer to see more detailed income and expense breakdowns.

Key point: Higher cap rate is always better....Lower cap rate is always worse.

Think of cap rate as your annual rate of return on your investment. 

If you purchase a property for $100k, and the NOI is $10k. The cap rate is 10% (you're earning 10% annually on your investment).

So, if your target is to buy at a 10-cap:

If the NOI is $15k...now the property is worth $150k to you.

If the NOI is $7,500....now the property is worth $75k to you.

This is essentially how cap rate determines price when using the income approach to value properties. Obviously, different markets produce different cap rates...and different investors are willing to accept different rates of return, making any given property worth more or less to different investors.

You do not include debt service when calculating cap rate, because the purpose to the cap rate is to compare different properties, or different asset classes (i.e. should I buy a rental property, stocks, bonds, gold, or whatever?). The debt service obviously impacts your cash flow...but not the cap rate.

Example...assuming you have $300k to invest:

• Property A's NOI is $10k, and it's listed for sale at $100k.
• Property B's NOI is $20k, and it's listed for sale at $200k
• Property C's NOI is $25k, and it is listed for sale at $300k

All things being equal*, would you use your $300k to buy property C? Or Use it to buy both A & B?

*All things are never equal...Clearly, it's crucial to dig into the details in real life:

• What if properties A & B are rented at full market rent value, but Property C is currently 20% below market? (And are the tenants month to month, or do they have a full year left on their lease at 20% below market?)
• What if Property B needs a new roof and HVAC, adding $25k to your acquisition cost?

I'll stop rambling now...Hope that helps! Good luck!