Investment Loans California

Capitalization Rates also known as “Cap Rates” is an analytical investment tool utilized by investors to determine the value of income producing commercial property in the market you are considering buying into.

There are basically three types of cap rate calculations related to the potential value of income producing property. If you know two of the three variables you can calculate the third. They are:

1. Purchase price of the property
2. Expected rate of return
3. Net operating income (NOI)
Note: NOI excludes non-cash expenditures such as depreciation for
determining cash flow.

Let’s assume an eight unit apartment building with a sales price of $1,500,000 with net operating income of $120,000.

What is the rate of return on this investment?

$120,000 divided by $1,500,000 = 8% return.

If the investor by chance wanted an 8% return, What should investor be willing to pay for a building with net operating income of $120,000?

$120,000 divided by 8% = $1,500,000 max purchase price.

If you know the market rate of return (8%) and the sales price ($1,500,000), what should be the cash flow generated from the investment?

$1,500,000 multiplied by 8% = $120,000 annual cash flow.

Let’s assume the apartment building only generates $100,000 cash flow annually. What would be the maximum purchase price the investor should be willing to pay?

$100,000 divided by 8% = 1,250,000 max purchase price.

In this example the building would be over priced at $1,500,000 and would not probably be a good investment. The property appraiser utilizes the cap rate as one of their tools in establishing the market value of the property. You as an investor should also understand and apply the capitalization tools in analyzing the potential acquisition of income producing properties