How to find a cap rate to find market value

[Shane Schrader]

Hello,

I am trying to place value on a mobile home park. It has 4 single wides and 4 RV trailer spots. Single wides are owned by the park. It's noi is around 4200 a month. I am looking for any ideas on how to find cap rates on something like this. Thanks in advance. 

[Wale Lawal]

@Shane Schrader

The capitalization rate is used to measure the profitability of commercial rental properties. A high cap rate indicates a relatively high income, relative to the size of the initial investment. However, there are also other factors to consider, such as risk and local market dynamics. Investors should be careful to consider a wide range of metrics in addition to the capitalization rate.

Since cap rates are based on the projected estimates of the future income, they are subject to high variance. It then becomes important to understand what constitutes a good cap rate for an investment property.

The rate also indicates the duration of time it will take to recover the invested amount in a property. For instance, a property having a cap rate of 10% will take around 10 years for recovering the investment.

Different cap rates among different properties, or different cap rates across different time horizons on the same property, represent different levels of risk. A look at the formula indicates that the cap rate value will be higher for properties that generate higher net operating income and have a lower valuation, and vice versa.

There are no clear ranges for a good or bad cap rate, and they largely depend on the context of the property and the market.
Say, there are two properties that are similar in all attributes except for being geographically apart. One is in a posh city center area while the other is on the outskirts of the city.

All things being equal, the first property will generate a higher rental compared to the second one, but those will be partially offset by the higher cost of maintenance and higher taxes. The city center property will have a relatively lower cap rate compared to the second one owing to its significantly high market value.

It indicates that a lower value cap rate corresponds to better valuation and a better prospect of returns with a lower level of risk. On the other hand, a higher value of cap rate implies relatively lower prospects of return on property investment, and hence a higher level of risk.

While the above hypothetical example makes it an easy choice for an investor to go with the property in the city center, real-world scenarios may not be that straightforward. The investor assessing a property on the basis of the cap rate faces the challenging task to determine the suitable cap rate for a given level of risk.

All the best!