Re: Capitalization Rates - Posted by Paul

Posted by Paul on December 20, 1998 at 21:14:46:

Cap rates follow the market and can be extracted from sales just as a GRM. Be careful when doing this though. Make sure when you extract cap rates that you know if the comp’s NOI includes a mgt fee and a reserve for replacement, just to make sure you are comparing apples with apples. It’s debateable whether or not to include these items for smaller apts., but just be sure you are consistent. As far as the 10% cap rate, that is a VERY rough rule of thumb. As a commercial review appraiser, I see cap rates all over the board. Properties of similar age, condition, size, income potential, will generally have a tight range of cap rates. If you can buy a property at the high end of the indicated range, then you’re doing ok. But more important is your cash flow. As an old boss of mine used to say, its no longer “location, location, location” that’s important, but “cash flow, cash flow, cash flow”.

There’s another way to calculate a cap rate, called the band-of-investment, which builds the rate from the mortgage and equity portions of the investment. It’s fairly simple and is based on the loan-to-value, the mortgage terms and your annual equity return requirement. The equation is as follows:

Assume: 75% LTV, 7.5% 15 year loan, 12% annual return on equity invested.

## mortgage .75 x .11124 = .08343

equity .25 x .12 = .03000

cap rate = .11343

The .11124 is called the mortgage constant, you need a financial calculator or mortgage tables to get this number. It is the number, which when multiplied by the loan amt. gives you the monthly payment.

Hope this helps…Paul