Does 10% Cap rate include rehab & closing costs

[Dinesh T.]

My realtor called into question my calculation when I stated that the CAP rate is low on a specific property she was showing. I had included rehab & closing costs. I have heard in podcasts about targeting 10% CAP rate. Is the norm not to include rehab, closing or any other costs of acquisition?

-Dinesh.

[Jim Pellerin]

Cap Rate is something that people are always asking about. They think it represents a return on investment. It does not, unless of course the property was fully capitalized. Meaning you paid cash for it. The other problem is that it's often misrepresented.

In answer to your specific questions, I would add acquisition costs and rehab costs in the calculation. You should also look at expenses. They are usually underestimated when presented by sellers or realtors. My Cap Rate calculations always include management and maintenance costs as a percentage. Oh, and don't forget to include a vacancy allowance when calculating income.

Here is one of the best explanations of Cap Rate I have seen:

http://www.wikihow.com/Figure-Cap-Rate

The best assessment that you should use when determining if it's a good investment is a Cash on Cash return. How much money are you earning relative to how much money you have invested. If you invested $40,000 and you are earning $4,000 per year after all expenses, then your return is 10% per year. Of course this doesn't take into account any appreciation or mortgage pay down. But that's just extra profit. I don't over complicate things and just want my investment to have a positive cash flow with a good rate of return.