When buying or selling properties, it is important to find the value of the property, whether it is a house or a commercial property. As with any attempt to find a property value, you must take into consideration many things, such as the condition of the home or building, and the location. If it is a commercial property, you will want to know the businesses capitalization rate. Because your home typically does not have an income source, the figure known as the capitalization rate is a necessary component of the property’s valuation.
What is the capitalization rate or cap rate?
The cap rate is a ratio used to determine the value of an income-producing property. Basically, the cap rate is the net operating income divided by the sales price or the property’s value, in terms of a percentage. Appraisers, investors, and lenders use the cap rate to estimate the purchase price of different types of income properties. The cap rate can be determined by evaluating the financial data of similar properties that have sold recently.
The cap rate calculation incorporates a property’s selling price, non-rental income, gross rental income, operating expenses and vacancy amount. A property tax assessment can help.
In any commercial property transaction, the seller will try to get the highest price for the property or the lowest cap rate. The buyer on the other hand wants the property at the lowest possible price, which gives the property the highest cap rate. The cap rate will vary from city to city and location to location depending of a number of factors: crime rate, desirability of location, and the general area’s condition. You will find lower cap rates in newer more desirable locations, and higher cap rates in less desirable areas to compensate for increased risk.
When you get a cap rate from an appraiser or lender it is important to know if the rate was determined by recent sales of like properties, or if it was constructed. Given enough financial data appraisers can construct a cap rate figure by using; NOI (Net Operating Income) divided by market value. NOI can be found by subtracting vacancy amount and operating expenses from a property’s gross income. Operating expenses include advertising, insurance, property taxes, maintenance, and property management, to name a few.
If you use the right software, you can actually come up with the cap rate on your own. Today’s software also allows you to come up with “what ifs” by plugging in your own values. This will help you narrow your search, if you are a buyer, and will save you time and money. You do not need a calculator and the data analysis will give you figures based on the last ten years of market data.