How to Calculate Cap Rates in Commercial Real Estate
Have considered investing in commercial real estate, but don’t know where or how to start? Today’s message can help with that.
One of the best ways to quickly determine if an investment property is a smart decision is to look at Capitalization Rates, or Cap Rates for short. Relatively speaking, cap rates will often vary for various reasons, but the most important reason is the RISK.
Cap Rates are generally used to measure the performance of rental real estate.
You can estimate your return by following a simple formula.
Net Income* / Purchase Price x 100
*Net Income = (Gross income - expenses)
Now — before I go on, it’s important to note that this formula takes into account many assumptions. You should be aware of this and not use the Cap Rate as the driving decision behind purchasing the investment property. It’s one of many ways to see the value of an investment property.
Here’s how it works in action. Let’s say you are an investor and considering buying a 10-unit apartment building for $1,250,000.
The monthly rent for each tenant is $1,200 and the property has about $3,600/month in monthly expenses. (Think: taxes, property management fees, insurance, maintenance, insurance, etc.) The purchase price for this property was $1,250,000.
What would your Cap Rate be — assuming it’s fully occupied all year round?
$100,800 / $1,250,000 x 100 = 8.06%
8.06% would be your return IF you paid cash for the property.
Your net income would be:
$144,000 - $43,200 = $100,800
Net Income Calculation: ($1,200 monthly rent x 12 month x 10 tenants) - ($3,600 x 12)
With a cap rate of 8.06%, this property has the potential to be a good investment property. But, as I mentioned earlier, there are many other factors to consider.
Have an Idea? Question?
Commercial real estate can be a great investment choice. If you have any questions, let’s chat! I have extensive background in almost all these types of the spaces, and would love to answer any of your questions.
