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What is a CAP RATE? - Commercial Real Estate Investing Part #1

By
Real Estate Broker/Owner with REAL ESTATE AMERICA - Ernie Cabrera

COMMERCIAL REAL ESTATE INVESTING   Part #1 

by: Ernie Cabrera from REA Commercial

 

How do you find out how much you will get as a return on your real estate investment?

How do you know what a property should be valued at?

How much income will an investment produce?

I am asked these question all the time from new investorswho are just getting into the commercial real estate business.  I think it is good to know some of the basic calculations that will help you evaluate investments.  There is much more to a properties value and it is more complicated to compare investments, but here are the basics.

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Capitilization Rate - It is used to evaluate what a property's income and to compare values. 

 

Cap Rate = Net Operating Income (NOI) / Sales Price (Value)

 

The capitalization rate (cap rate) is defined as being a measurement of the ratio between the cash flow produced by an asset (NOI) and its capital cost (purchase price) or its current market value.

So in simple terms it is the income produced by an investment (NOI) divided by the current or future value of that said property gives you the cap rate.

If you have two out of the three values in this formula, you can get the other value:

Sales Price (Value) = Net Operating Income (NOI) / Cap Rate

Net Operating Income (NOI) = Cap Rate / Sales price (Value)

 

I hope this helps explains some basic questions on what is your return on your real estate investments.  Please stay tuned for additional parts to this series.

 

COMMERCIAL REAL ESTATE INVESTING PART #2 (coming soon)

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WWW.REACOMMERCIAL.COM

 

 

Comments (10)

Sal Poliandro - Helping People Win
RE/MAX Properties - Ridgewood, NJ
Broker Associate

Ernie,

     Thank you so much. You really spelled it out in a concise and easy to read way. 

Oct 20, 2007 04:46 PM
Ernie Cabrera
REAL ESTATE AMERICA - Ernie Cabrera - Elk Grove, CA
Real Estate America
Sal and Dawn, thank you for you kind words about my blog.  I hope you find the rest of them interesting too.  I hope we can do some business together in the future!
Oct 20, 2007 06:46 PM
Steve Coutrakis
REAL ESTATE AMERICA - REA - Gold River, CA
Ernie, thank you for posting the information about Cap Rates.  It is what investors need to know about commercial real estate.
Oct 22, 2007 03:26 PM
Mike Norvell Sr
Morris Williams Realty - Leesburg, FL
Norvell Consulting Group
Hey Ernie, what is the average cap rate being sought now in California?????
Dec 02, 2007 11:07 PM
Ernie Cabrera
REAL ESTATE AMERICA - Ernie Cabrera - Elk Grove, CA
Real Estate America

Steve, thanks for stopping by and commenting.  I am glad you liked it.

Mike, I would love to say it is at 10%, but that is rare.  The average cap rate that I am seeing is in the range of 6.5% to 8%.  We are now near or at the peak of the commercial real estate cycle and it will be heading down because of the vacancy factor increasing.  What is the cap rate in your area?

Dec 04, 2007 07:33 PM
Rick Duffy
Keller Williams Integrity R.E. - Saint Paul, MN

Thanks for the re=fresher, I understand what the terminolgy is, but hard pressed to explain it to some one else.

Uncle Duff

Dec 05, 2007 07:21 AM
Ernie Cabrera
REAL ESTATE AMERICA - Ernie Cabrera - Elk Grove, CA
Real Estate America
Rick, thanks for stopping by this blog and reading it.  I am glad to pass on a refresher to a veteran real estate professional like yourself and I will call you Uncle Duff!   :o)
Dec 06, 2007 02:51 PM
Lanre-"THE REAL ESTATE FARMER" Folayan
Samson Properties - Bowie, MD
I don't make promises.I deliver results.SOLD HOMES

Net Operating Income (NOI) = Cap Rate / Sales price (Value)-I dont seem to understand the calculation. I understand the other two. But this one doesn't quite add up. If you can explain,I would really appreciate it. Great post.

May 28, 2008 02:03 PM
Anonymous
Anonymous

multiply dont divide

Jun 04, 2008 12:37 PM
#9
Christina Sanchez Hood
Palo Alto, CA
#SiliconValleyHOODS | Inspired Living

Thanks Ernie, that is a useful post :)

Aug 15, 2014 04:20 PM