What's it Worth?- Deriving Your Capitalization Rate

Overview: Among the many tools used by investors to gauge the worth of an income property, one of the most popular is a capitalization rate, aka cap rate. But as it is typically used, it is probably the one most misused concept in the real estate investment business. While brokers, sellers and lenders alike are fond of quoting deals based on the "cap rate", the way it is typically used they are really shortcutting the true use of a valuable tool. Brokers are also fond of quoting a "market cap rate." This is an effort to legitimize an assumption, but it is flawed in its source. As a comparison tool it is almost impossible by any means to find out what other properties have sold for on the basis of the cap rate. In order to correctly calculate a cap rate, and get an apples to apples comparison, one must know the correct income and expenses for the property, and that the calculations of each were done in the same way as will be explained below. Many factors can influence the value of an income property both up and down. Some of the most important include deferred maintenance; security of the income stream (strength of the tenants and length of the leases); comparable sales in the area; general economic and market conditions; and local market conditions.

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Format: HTML | Date: Jan 2003 | Pages: 1