Sometimes I have people who ask me what is the cap rate of a residential rental property. Normally that is the wrong question. A capitalization rate is a way of finding value based on the net operating income. That is income before interest and taxes. It is most often used in commercial real estate where value is more driven by rental rates than appreciation which is where residential real estate gets its rate of return on a long term hold. Simply put, if after expenses you have a 10,000 net operating income and you figure it on a ten cap then the property is worth $100,000. When buying a new property to rent your first year cap rate will not be as high as your five year when figuring value, if the market is appreciating. We are starting to here more questions like this in residential because people are unsure of appreciation in a national market downturn, and the investor wants income up front. In that respect it can be the right question.
So how do you get a cap rate of 10% or more in todays market? First you have to find rents that are considerable higher than the purchase price. For instance, if you buy a $150,000 property and the rent is $1250, then after an 8% to 10% management fee, and maintenance cost, a 10% cap rate is not possible. That does not make this a bad buy in Oklahoma because we are appreciating. Where 10% rates exist is in lower price ranges, typically below $80,000. Let's take a $60,000 home in a decent neighborhood, you can expect a rental rate of $700 per month. If property management is capped at $50 per month, and the home is in good condition with recent capital expense upgrades, then maintenance and property management will be low enough that a 10% rate can be achieved. An advantage to buying this type of property is that rents compress on the low end so that going $20,000 lower on a purchase may result in only a $50 per month drop in rent. Another advantage is that many more renters can afford payments so you have more renters than property available, and very low vacancy rates.
Tomorrow I will blog about examples of these types are properties that are currently available. We have 30 homes under $80,000, many with granite counter tops, new appliances, all tile floors, and updated central heat and air. 24 of them are currently rented and the management fees are 10% with a maximum of $50 per month regardless of price. We also have a property manager that personally picks up rents due so the properties are seen every month. If you want to be put on a list of available rental homes, please email me with your criteria at joe@joepryor.com.
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