Another method investors use to evaluate an investment is the Capitalization Rate. This is a very basic easy to use tool, but you need to have a good idea about what your Net Operating Income will be. It evaluates profit, not gross income and may be a better tool than Gross Rent Multiplier. A Free Capitalization Rate Calculator is now attached to the Spread Sheet Providing Calculators and Examples. If it is not on the Spread Sheet you are currently working with go to the Investors Page at my web site and down load it now.

The Capitalization Rate is very simple: You divide the Net Operating Income by the Asking Price:

Net Operating Income/Asking Price = Capitalization Rate

So using our in Part 6 A, if the projected Net Operating Income is $13,700 with an Asking Price of $200,000.00 for a piece of property the Capitalization Rate is 6.85%.

$13,700.00/$200,000.00 = 6.85%

Like the Gross Rent Multiplier you really need to know what the Market Capitalization Rate is to compare. This information may not be readily available and rents may really vary in a market. The buyer should have an idea as to what Capitalization Rate they want to achieve.

However, if a buyer has a particular Capitalization Rate in mind you may also use the Capitalization Rate as a way to determining the price to pay. Simply reverse the formula: Divide the Net Operating Income by the desired Capitalization Rate to find a Maximum Offering Price:

Net Operating Income/Desired Capitalization Rate = Maximum Offering Price

Taking our example above: A buyer feels he needs to achieve a 7% Capitalization Rate and the Net Operating Income is $13,700.00.

$13,700.00/7% = $195,417.29

The Maximum Price the buyer would want to offer is $195,417.29.

The Higher the Capitalization Rate the better. This is just one tool we will be using to look at investments. Follow these post and subscribe to this Blog for more information.

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