Purchase Cap Rate vs. Pro Forma Cap Rate

[Michael Letarte]

What's the difference between Purchase Cap Rate vs. Pro Forma Cap Rate.  I have been using the calculator and can't figure out the pro forma cap rate.

[Brandon Turner]

Hey @Michael Letarte - good question. 

So, the cap rate is the annual net income / value. But because some properties need repair costs, it's hard to know what they mean by "value." 

So - purchase cap rate is the actual cap rate when it was purchased. The Pro Forma cap rate is based on the after repair value of the property.  Does that make sense?

[Michael Letarte]

That makes perfect sense.  I have been printing the pdf's and trying to explain them to people.  I also wanted to make my own spreadsheets because I dont think my documents should have biggerpockets' disclaimers on them.  I love how the analyzer archives the reports and provides a status bar on each property.  

Thanks

[John Lindemann]

@Brandon Turner - How is the NOI being calculated in the calculator?

I thought it should be Income - Loan Payment but there seems to be something else being considered as well...?

[Ben Unger]

@John Lindemann

NOI = (Total Gross Monthly Rent + Other Monthly Income - Total Monthly fixed Expenses - Variable Landlord Expenses)*12 months

Your mortgage interest may be a deductible expense, but it is not an operating expense. You may need a mortgage to afford the property, but not to operate it.

[Jeff B.]

Pro Forma refers to the FMR that SHOULD be collected. Without that adjective, the GSI should be taken as the ACTUAL rents.

Cap rate is the NOI / the purchase price, and NOI is directly derived from Actuals vs Pro Forma.

IMO, NEVER run your numbers using pro forma, as it's too easily misquoted and it becomes another problem in your due diligence process; use the Actual Rents at the time of you offer.

[Cody Barrett]

Great information here, thanks guys!

  @Jeff B. lets say someone finds something on loop net with pro forma data given via links on the advertisement from the Commercial Broker.  Would you then contact the broker to ask for rent rolls, 2 yrs of income/expense statements, and anything else that would contribute to actual data that can bring someone to a more solid valuation using the market CapRate?  I guess the whole trust but verify kind of deal?

Thanks for your input, always enjoy reading your responses and experiences! 

Cody

[Ned Carey]

@Ben Unger

I never heard it put that way. That is a simple and clear way to explain it.

[Stephen Chatto]

Started playing with the Bigger Pockets Rental Analyzer today.   Seems like the purchase cap rate does not take into consideration the initial investment in repairs.  

For Example : https://www.biggerpockets.com/sharable-pdf

NOI is 540 Per month, Purchase Price is 50k. So purchase Cap Rate is (540*12)/50,000 = 12.96%

That is not taking into consideration the repairs needed on the house of 8,000.  

I get that the 8000 is not part of the purchase price, but an initial expense needed as soon as purchased, so it seems like it should be included in the purchase price cap rate.  

Thoughts?

Seems like the "Cash on Cash ROI" is the most relevant Cap Rate on the proforma.

[Account Closed]

The $8,000 Is not part of NOI. It would be a below the line adjustment that would lower the purchase but have no effect on the cap rate.

[Blake Lawrence]

So how do you include the 8k in your calculation. I would think if you want an accurate picture for investment sake you'd want NOI/(purchase + rehab). Or will that only work if both are paid cash in full. Sorry first question since joining, might be a bit newbish.

[Jared Henderson]

Blake, what you'd be looking for is the Cash ROI, which does include improvements+repairs. Total ROI Includes Equity as well as Cash

[Marty True]

@Brandon Turner what many fail to look at also, is not just the ARV for pro forma but real estate taxes. @Jeff B. mentions to never run your numbers on pro forma, and I agree 100% with one exception... RE taxes!

Here in Miami Beach, sellers love to show their current RE taxes for the CAP they're claiming but 98% of the time, the current assessed value is much lower than the asking price. So as soon as you purchase, your RE taxes can double or worse.

So when running your numbers, especially in 5+ unit MF, be sure to run calculations based on the new assessed value and the increase in taxes. Luckily, our property appraiser's website for Miami-Dade county has an estimator tool that helps you to calculate the new taxes based on a potential sale price.

[Avrohom New]

@Marty True 1,000 percent. See it everyday. Could impact ROI drastically.

[Justin Conklin]

@Michael Letarte, I was looking into the same calculations today, and came across you post for 2 years ago.

Running the calculations myself, I figured out the calculator performed the following:

Pro Forma Capa Rate = ((Monthly Income - Total Operating Expenses)*12)/After Repair Value

where 12 is the number of months to get the yearly rate

Purchase Cap Rate = ((Monthly Income - Total Operating Expenses)*12)/Purchase Price

Note: Terms above can be found on the final report provided on the calculator or easily determined yourself from your calculator inputs.

I hope this helps.  If not you, perhaps someone else.

[Yoni R.]

This is driving me crazy. I used the BRRR calculator and can't understand something.

Bought a house for 190,000 the ARV is 260,000. Rehabbed for 25,000 plus closing of 3,000. total all in for 218,000. refinanced after 8 months and received a 70% refinance 182,000 at 5% interest.

How is the "Cash on Cash ROI" in year 2 - 10.77%?

26,928/260,000 = 10.35%. And if my actual cash flow for the year after expenses is 3,875 and my cash now invested in the deal is only 78,000 now, then shouldn't my Cash on Cash ROI be 3,875/78,000= 4.9%?

What am I figuring wrong???

2%/year
Expense Increase

2%/year
Income Increase

2%/year
Property Value Increase

	Year 1	Year 2	Year 3	Year 5	Year 10	Year 20
Total Annual Income	$22,000.00	$26,928.00	$27,466.56	$28,576.21	$31,550.44	$38,459.81	$46,882.30
Total Annual Expenses Operating Expenses Mortgage Payment	$13,775.47 $5,140.00 $8,635.47	$23,052.29 $5,781.36 $17,270.93	$23,167.92 $5,896.99 $17,270.93	$23,406.16 $6,135.23 $17,270.93	$24,044.72 $6,773.78 $17,270.93	$8,257.21 $8,257.21 —	$10,065.49 $10,065.49 —
Total Annual Cashflow	$8,224.53	$3,875.71	$4,298.64	$5,170.05	$7,505.73	$30,202.61	$36,816.81
Cash on Cash ROI	22.85%	10.77%	11.94%	14.36%	20.85%	83.90%	102.27%
Property Value	$265,200.00	$270,504.00	$275,914.08	$287,061.01	$316,938.55	$386,346.32	$470,954.01
Equity	$87,328.26	$101,204.28	$115,624.94	$146,199.60	$234,040.22	$386,346.32	$470,954.01
Loan Balance	$177,871.74	$169,299.72	$160,289.14	$140,861.40	$82,898.33	—	—
Total Profit if Sold *	$35,684.79	$52,959.16	$71,191.55	$110,663.08	$228,579.50	$565,007.70	$979,325.04
Annualized Total Return	99.12%	57.20%	43.86%	32.44%	22.07%	15.11%	11.77%

[Matt Wallington]

you should be calculating cash ROI as $3875/$36,000 which would bring you to the 10.77%. If you were all in for $218,000 and then refinanced and cashed out 182,000 you now only have 36,000 invested.

[Christine Johanns]

HELP!!!!!!! Bad deal ...so so deal... I have all of the numbers right. It's a turnkey property. Nothing need to be done except a little yard work. Tenant in place. Would be first ever purchase. All cash.... :( I'm confused.

https://www.biggerpockets.com/calculators/shared/8...

[Brad Bellstedt]

I want to make sure I am understanding this correctly. The "Purchase cap rate" is solely based on what the property is purchased for and it's ROI, and the "Pro forma cap rate" accounts for the purchase price, repairs, and ROI. Is that correct? If so, the Pro forma should ALWAYS be lower than the purchase cap rate, right? Unless you calculate with no repairs. Is that correct?

[Michael Ramsay]

One more thing to consider....

Pro Forma includes the equity as part of the invested money.  

1. You bought a 250k property with cash that's worth 250k. It has a NOI of 25,000 so you proforma and ROI are the same at 10%.

2. You bought a 250k property with cash but it's worth 500k. You have 250k equity in the house. The NOI is 25,000 so you proforma is now 5%, but your ROI is 10%.

The difference in the two is the equity that isn't being captured.   So in situation 2, your actual money is making 10%...but your potential money is only making 5%.  

[Craig Anderson]

Originally posted by @Brandon Turner:

Hey @Michael Letarte - good question. 

So, the cap rate is the annual net income / value. But because some properties need repair costs, it's hard to know what they mean by "value." 

So - purchase cap rate is the actual cap rate when it was purchased. The Pro Forma cap rate is based on the after repair value of the property.  Does that make sense?

So, should the purchase cap rate be in the 4-8% range and the Pro Forma should be 10%-15%?  Or, is there another way to look at those numbers?