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Definitions
Internal Rate
of Return
Modified Internal Rate of
Return (MIRR)
Net Operating Income (NOI)
Loan to Value Ratio
(LTV)
Cash on Cash Return
Capitalization Rate
Gross Rent Multiplier
(GRM)
Debt Coverage Ratio
(DCR)
Real Estate Terms |
Capitalization Rate (Cap Rate)
The Capitalization Rate (“Cap Rate”) is a
ratio used to compare properties with different valuations, and to also
place a value on a property based on the income it generates. The Cap Rate
is computed by taking the rental net operating income (NOI) and dividing it by the property's fair market value (FMV). The higher
the Capitalization Rate is the better.
Cap Rate - Practical Use #1
You can use the Cap Rate to value your
property. Let's say that your property generates $10,000 of annual net
operating income. Your real estate agent tells you that the Capitalization
Rate in your area is approximately 4%. That would mean that the approximate
fair market value of your property is $250,000 ($10,000 / .04).
Cap Rate - Practical Use #2
Let's assume that you are looking at
investing in two properties. The first property has a projected NOI of $20,000 and an asking price of $500,000. The second property has a
NOI of only $10,000 but an asking price of $110,000. Which one would the
Cap Rate suggest is a better investment? That's right, the second property
since the Cap Rate is 9% ($10,000 / $110,000) versus 4% ($20,000 /
$500,000).
If you are able to obtain reliable
capitalization rate data, you can then use this information to compare to
the output that the Landlord’s Cash Flow Analyzer ® Pro gives you based on
your input. This will help you to gauge whether or not the asking price for
a particular piece of property is over or under priced. |
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