Cash on cash & cap rates

[Jonathan Jackson]

Hey BP fam can anyone please help me with calculating the cash on cash return and cap rate. I just want to make sure I’m doing the right calculations.. for the cash on cash I’m doing the annual net cash flow/ total cash investment times 100 and for the cap rate I’m doing net operating income/ sellers price...Also what would be a good cash on cash return and a cap rate ratio

[Mike Roy]

@Jonathan Jackson I would say you need to know the market cap rate for the class and type of property you are buying (and what that cap rate will be in the future) because that will determine your selling price in the future. 

However, you don't want to buy a particular cap rate. For one, anyone advertising an above market cap rate probably means there are hidden problems in the property, the area is bad, or the numbers are disingenuous. In fact, some of the best deals are offered at very low cap rates because there is so much opportunity to increase NOI. This means that you can buy a 2-3 cap and "turn it into" a 10 cap. However if your market sells at a 7 cap for stabilized properties of like class and type, that difference represents your forced appreciation.

Ex. You pay $100k for a property with $2k NOI (2 cap). You raise rent and reduce expenses to increase NOI to $10,000 (10 cap). Your market sells at a 8 cap. $10k NOI/.08 = $125k in value. You forced $25k in equity.

Also, just remember that any NOI you add can be divided by the market cap to determine the value added to the asset.

Instead of buying on cap rate, buy on projected cash on cash return (cash flow/[down payment plus initial repairs]).  That's your real return.

Best way to find out cap rates in your market is to speak with experienced brokers who deal in the asset class you're interested in.