Everybody, Sunny with Synergy Real Estate & Property Management in Bakersfield, California back here with you. Today we are going over some real estate terms this time. We’re going to talk about cap rate in real estate, specifically commercial real estate or investment real estate. You’ll see a term or hear a term called cap rate in the real estate being thrown around quite a bit.
What is a capitalization rate?
Cap rate is basically an indicator that you can use to see whether the property is going to return to you. What you think it should or what you think is right for the area. So what you’re going to do with a cap rate is you’re going to take the net operating income of a property. You’re going to divide that by the actual purchase price of the property and the sales price of the property.
How to Calculate a Cap Rate?
That’s going to give you a percentage rate. Right. So let’s just say that we have a property that has an NOI(net operating income) of $10,000 a year, and we have a purchase price of $100,000. So if we take that we divide them together, you’re gonna see that we have a 10% cap rate. Now, what does that mean? So basically what that means is after we take all of our expenses out. Assuming we purchased the property in cash as well.
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We’re left with X amount of dollars. And so that would be $10,000, and we purchased the property for $100,000, meaning we take the 10,000 divided by the hundred thousand that’s one 10th of 10%. Right. So now we know that this property is going to give us a cap rate of 10% Now, is this relevant to us, right, most investors are not going to be purchasing properties in cash right and so obviously that’s not going to matter at that point.
What is the ideal cap rate?
Now if you use different leverage, that’s going to change a few of the other indicators that we have but it may not change the cap rate indicator as much as well. What you’re looking for in this scenario is, you’re looking at it more as a tool to use apples to apples right so if we look at this property and we get a cap rate at 10 we look at that property get a cap rate of 5, and we keep on going and we realize well there’s an average here of about 8.
Anything over these eight seems to be pretty good for me. So, that means then that should signal a property that I should look more into right and so obviously we’re not going to use the cap rate as a sole indicator. There is cash on cash returns internal rates of return. They’re just cash flow right a lot of beginning investors will just trade on cash flow right. They don’t care if the return is 10% or 5% as long as I’m making you know $100 or $200, right, something like that.
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So definitely everybody has their different ways of looking at properties and how they value properties you can use your gross rent multiplier as well. And so we’ll go into all of these different terms but specifically staying on cap rate, we’re looking at cap rate being a very useful kind of comparison tool, very easy to get get to comparison tool that will compare all kinds of properties and all kinds of markets to give you a good idea of what you should purchase and maybe what you should stay away from. And again, this is just a sole indicator so it’s not something that should make your decision on whether you purchase a property or not, there should be one factor of whether you decide whether to purchase property or not.
How we can help?
So again, Synergy Real Estate and Property Management here specialize in commercial and investment real estate. Here in Bakersfield we also are happy to do residential property; we have a residential arm as well. We have a property management arm as well. So if you need any help with residential, commercial, investment property management, we’re more than happy to help you. And we will be happy to talk to you.
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Sanjeev (Sunny) Advani
Office Lic 02012941