Reading Cap Rates and Pro Formas

[Solon S.]

I've been going around a lot of sites, including Loopnet, and have been looking at the Cap Rates that agents are claiming their listings are providing. They'll claim that a property has a 5% cap rate, priced at $1M, with annual rents coming in at $64k. It appears all they calculate in the expenses are taxes and operating expenses (11k total) and come out with the calculation. (Keep in mind, this is a Brooklyn property, hence the inflated numbers).

I guess my question is, should that be the only thing calculated in the expenses? Are the real estate agents presenting these cap rates in their pro forma's portraying them accurately? It seems like they're all doing the same thing. They're not considering the cost of financing, vacancy, or maintenance as applicable expenses. I wanted to get this clarified as I feel like hammering this out will help in negotiating deals with certain agents/sellers. Also, I don't want to enter an overpriced deal.

Thanks in advance for the feedback.

[Account Closed]

Hi Solon,

Great question - this can be really frustrating. For starters, find out what the cap rate is from your own research: recent sales of comparable properties, call local assessor's, search online (I recently found New Hampshire posts their own opinion of cap rates!), and call all sorts of Brokers and Managers.

In terms of analyzing deals, I don't like making offers on potential income or broker's suggested expenses.. I like making offers on actual numbers, a Trailing-12 (T12) and a rent roll and then request proof of these statements once you're under agreement. And of course, take a step back and input things such as vacancy or higher maintenance or your own management costs etc.

Jon