Calculation of a Commercial Propertie

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Calculation of a Commercial Propertie

Uwe S.
Property Manager · Dublin, OH · Member since 2009 · 1k+ posts · 291 votes

Hello :),

I saw in Brandons Topic the calculation of commercial properties in the US. I was little confused about this.

CAP RATE = NOI / COST
therefore
COST = NOI / CAP RATE

is okay for me, but in Brandons case the Cost is $580k (purchase price of the apartments), when I divide the NOI of $70k with $580k I become 12.06% CAP Rate. And $70k divided with 0.1206 is $580k.
But why involve the surrounding areas? In Brandons case 8.5% CAP, so he calculated and came to a value of $823k for this complex. In California it gives areas with 4% CAP in this case the value is $1,75 million. I can´t understand it.
Lower CAP rates = higher propertie value?

In Germany we calculate for the whole complex and only for the complex, not the area. Is the CAP Rate for the complex 12.06% and brings the property $70k NOI, then we make following.

VALUE = NOI x CAP ($844k = $70k x 12.06)

Is the area involved with 8.5%, the calc would be ($595k = $70k x 8.5), so the value only $595k for the propertie (undervalued).

Maybe I have a lapse now, but its important to correct this for my calculations in the US. So please help me out.

Thanks Brandon and Vikram for this impulse.

-Uwe

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  • Vikram C.
    Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
    17y

    Uwe, the "cap rate" is simply a phrase that has a specific meaning in the U.S. It is NOI divided by cost. You can think of it as the unlevered cash flow return from a property in its first year. Therefore, higher cap rates mean higher initial cash flow as a percent of your total investment.

    To be honest, in advanced finance the cap rate is not used much. And it is not really related to the return on an investment because it does not consider factors such as appreciation, leverage, cost of debt, etc. But it seems to be a commonly used term in practice and we may as well get familiar with its usage and meaning.

    You asked why cap rates vary so much from place to place. In theory, the cap rate should be lower in places where rent is expected to grow faster because you will be willing to give up some current cash yield in return for more cash yield in the future.

    Having said that, I also believe that some cities simply have poor investment opportunities. I cannot imagine paying a 4-cap in the San Francisco Bay Area as opposed to a 11-cap in Texas.

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  • Uwe S.
    OP
    Property Manager · Dublin, OH · Member since 2009 · 1k+ posts · 291 votes
    17y

    Vikram,

    fine, thats the answer to my problem.

    In Germany we seeking the last three years NOI and compare it with the sales price, then we have our "German CAP". Then we calculating the gross income with 15% vacancy (firm factor) and less estimated expenses and we have a round figure of the new NOI. These both numbers multiplied and we have the propertie value.

    Thats byzantine ^^. Thank you Vikram.

    -Uwe

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