How do you calculate cap rates?
Also known as capitalization rate, it is used in the income approach to appraising property values. Real estate investors are typically very concerned with this number especially if their goals involve long term cash flowing rentals.
But it even applies to the fix and flip method of investing as well!
Learn how to understand cap rates in this weeks episode of Ask the Instructor so you can help broker investor deals and earn commissions or use the information for your own personal investments.
If you are into Real Estate Business but don't want to get involved with Closing Deals for Residential or Commercial Transaction and live from its sweet top-dollar commission rates. You still have a room! You can be a Real Estate Investor!
Being a Real Estate Investor requires knowledge if you want to be successful with it. Today, we are going to discuss how you can calculate cap rates, what factors/variables you need to know for you to build an effective real estate investing with better return of investment.
Let’s start with knowing what are the variables that you need to know before you entitle yourself as a Successful Real Estate Investor.
- PGI (Potential Gross Income) — This value will be your annual gross income after getting settling up your monthly rent rate with a tenant, to simply put, this will be (monthly rate amount * 12 months) = PGI.
- Vacant & Collection Loses (V&C) — It’s not always rainbows and butterflies in real estate investing, there will be a time that you will have losses like, the property went vacant, tenants refuse to pay the monthly rent that you need to force evict, can’t make or are late with payments. These are the variables that you wanted to have in mind together with your calculation, and you can easily get this by counting the number of months that they paid and divide it against 12 months and multiply the result from the PGI. To simply put, [(unpaid-months/12 months)PGI] = V&C
- Effective Gross Income (EGI) — Just the name itself, this will be your effective calculation of your Gross Income since we are going to take off the losses that you have experienced/expected through the year from PGI value. To simply put, (PGI - V&C)= EGI
- Operating Expenses (OE) — Keeping your property well-furnished and making sure it is in good shape means you need to spend some money repairing and renovating it. You can come up with the budget size figure per annual or if you are an expert with this, you can give the average amount for the repairs/renovation needed.
- Net Operating Income (NOI) — This will be the overall income that you’ll take inside your pocket (excluding Tax, and Mortgage Payment), you can simply get this by taking off your Operational Expense from your Effective Gross Income. To simplify, (EGI-OE)=NOI.
- Value of the Property (V) — This is the total amount that you invested on the property.
- Capital/Cap Rates (R) — is the most popular measure through which real estate investments are assessed for their profitability and return. You can simply get this by dividing total NOI to Total Value of the Property. To simply put (NOI/V) = R.
Great to know that now you know what were the variables for you need to know to gear you up with Real Estate Investing. Just a quick tip before we end. You can also force appreciation value increase with your Total NOI by just adding an extra amount on your monthly rent, you simply do that by adding new amenities with your property that justify the increased rental cost.