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How to calculate cap rate

I often get asked by new investors into the commercial side of real estate “How do I figure out the cap rate?” While GOOGLE is always a great resource to help find the answer, here is the simple version from my perspective. To figure out the cap rate you have to first determine the current market value of a business/building etc. Let’s say you are thinking of buying an 8 unit townhome complex. Current market value for that property would be, let’s say, $1,600,000.

You then need to find out the net operating income for all the units combined. How much money to you would all the units bring in combined, before any expenses, for the ENTIRE YEAR. So, each unit rents for $1,200. You multiply 8 x $1,200 x 12 which equals $115,200 for the year. Now, to get your cap rate you are going to divide that yearly amount by the fair market value (some realtors will use a list price to figure out cap rate, but more accurate numbers are fair market value) $115,200 divided by $1,600,000 for a cap rate of .072 (7%).

There you go, a simple view of cap rate calculations. There are other things to look for as well (expense ratios and gross rent multiplier) but this is a simple way to help you determine good value. Remember, the higher the cap rate the better. Good purchases are double digit cap rates. If you are looking for a double digit cap rate property, let me help you find it.

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