Buy and Hold Calculations

[Andrew Schena]

Hey Everyone...I've got a question for those who are familiar with calculating the Cap Rates and Appreciation on buy and hold investment properties.

Should your cap rate calculation include the costs of improvements and closing costs?

Should your appreciation calculation include the expense of closing costs when acquiring the building?

Thanks!

Andrew

[Brian Burke]

There are two different kinds of cap rates (actually there are many different kinds cap rates but two that are relevant to your question).

Going-in cap rate would be the NOI divided by the purchase price. This is the one that brokers commonly use when selling property and new investors use to talk about the great deal they just made. :)

All-in cap rate is NOI divided by the sum of purchase price, closing costs, and up-front renovation costs. This is more of a true measure of investment performance. On the surface you might assume that the all-in cap rate is always lower that the going-in cap rate, and in many cases it is, but it doesn't have to be. If your renovations allow you to immediately increase the income and/or reduce expenses (such as maintenance or utilities), it is possible that your all-in cap rate might be higher than your going-in cap rate.

I'm not sure what you mean by your question about the appreciation calculation. If you are valuing an income property you don't forecast future value by appreciating the real estate, you do it by appreciating the income and then calculating the value by dividing the future income by the cap rate. Forecasting what that cap rate should be is an entirely different matter, however! If you are talking about 1-4 units, disregard this paragraph, it wouldn't apply.