Capitalization Rate: True Value Or Complete Nonsense?
Many real estate investors determine the value of an income property by using the capitalization rate, also known as the “cap rate.” However, this is absolutely the one most misused word and concept in real estate investing.
What is it? A real estate broker prices a business and its associated building by taking the Net Operating Income (NOI), dividing it by the sales price or, alternatively, the current market value; then you get the “published” capitalization rate.
While brokers, sellers and lenders are fond of quoting deals based on the cap rate, the way it is typically used, they really shortcut the true use of the real cap rate.
For example, let’s say the property has an NOI of $155,000, and the price is $1,155,000.
$155,000 / $1,155,000 = 13.4% cap rate
But what does that number really mean? Does it tell you what your return will be if you use financing? Absolutely not. Does it take into account the different finance terms available to different investors? Absolutely not. Then just what does it show?
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Regards,
Pete Baldwin
Designated Broker
Platinum Realty Network
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