Posted by speednxs on December 14, 2005 at 11:23:16:
Don’s advice is very good. There is a nice mathematical phrase “necessary but not sufficient”. It is necessary to have a good cap rate but not sufficient. CAP = NOI/Price. Net Operating Income can be calculated to a wide variety of numbers. NOI doesn’t include your labor. 5 hours a week is a lot different from 10 hours a week. If you want to amortize a $15,000 roof over five years, that could blow your NOI to heck.
The problem is that people want to invert the formula to Price = NOI/CAP. A higher CAP is better for the investor (more income) but worse for the seller (lower price). Suppose a $2,000/month NOI. $24,000 NOI per year. With a 3% CAP the building is worth $800,000. With a 10% CAP the building is worth $240,000. Remember NOI can have a wide range depending on the assumptions in the calculation.
You still have to research Comparable Sales very careful to come up with reasonable price. Don’t be suckered into “a 3% CAP is normal for this neighborhodd because of the high appreciation”. Landlording takes significant effort and is not like buying a stock.
When evaluating 4f is cap rate effective. Which i believe is used specifically for comm’l property. Cash on cash,GRM,ROI calculations used ONLY for comm’l? For multi-unit residental what is practical?
Re: Residental vs Comm’l Formulas - Posted by Don Dion
Posted by Don Dion on December 13, 2005 at 17:44:25:
When looking at an investment there are many items to look at: Rent, Vacancy, Operating Expense, Debt Service, Cashflow before Tax, Appreciation, Tax Liab and Term of holding the investment.
Depending on the experience an suffistication of the buyer & broker these rules of thumb seem to run in this order:
SF/Comparison: looks at none of the numbers just compares a sq ft cost of one building against the sq ft cost of another.
GRM: looks only at item one Rent’s
Cap Rate: looks at Rent, Vacancy & Op/Exp only
Cash on Cash: Rent, Vacancy, Op/Exp and Debt Service
Equity Rate of Return: Rent, Vacancy, Op/Exp, Debt Service, and Appreciation.
Discounted Cash Flow:
Rent, Vacancy, Op/Exp, Debt Service, Tax, Appr, Tas Liab, Term and in some reports give you an out look to the future at 5yrs or 10yrs depending on how long you intend to hold the property as to what the sales price will be based on the 3 types of markets.
As you can see the further you go down the list the more informed an investor you become.