There are several different ways to assess the value of an investment property. If you are considering purchasing an investment property, you’ll likely want to estimate your return on investment (ROI). To do so, you can pour over comps, you can have the property appraised and you can review the rent roll, or the current rental income. But many savvy investors also rely on the capitalization rate, or cap rate.
Doing the Math
Simply put, the cap rate equals the net operating income (NOI) divided by the value (sales price).
The NOI is calculated by taking the yearly income of the subject property and subtracting any operating expenses, other than your debt (i.e. property management fees, maintenance, taxes, insurance). Once you have this number, you will divide it by the purchase price to get your cap rate.
Now you have the rate. But… what does it mean? Analyzing and using the cap rate seems to be where most people run into trouble. You might assume that a higher cap rate means a higher ROI, and would therefore be more desirable. That’s not necessarily always the case. A higher cap rate can indicate that a property is a higher risk, while a lower cap rate can indicate a lower risk investment.
If it is your goal to find a property that you can add value to and increase profitability, you’ll want to zero in on a property with a lower cap rate. If you want to invest in a fully-stabilized investment property, your best bet is to look for an investment with a cap rate similar to the average in your area.
Local Cap Rate Averages
Where can you find information on local cap rate averages? You guessed it! Your local brokerage. Here in northern Nevada, Miller Industrial Properties handle investment transactions each and every quarter and offers free information via our quarterly Market Advisor. If you are looking to invest in northern Nevada, it is important to be knowledgeable about our local market, which is transforming rapidly. In the West, cap rates can vary almost one hundred percent. If you want to talk numbers, please give us a call. We would be happy to guide you.
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