How does a bank calculate cap rate? Will I have instant equity?

[Rachel Luoto]

HI BP! Does anyone know how a bank's appraiser concludes cap rate in deciding property valuation? My NOI/purchase price puts cap rate at double(!) the market cap. Will a bank use the lower market cap rate to appraise, giving me a large portion of equity? I like to use equity for HELOC/cross collateral to buy more properties, this deal already has nice cash flow but the equity would be a big win to drive business forward! Cap rate is tricky, people's advice is just to get broker's opinions, which seems like shaky ground for making big investments, if anyone has a better resource I'd appreciate it!

[Alvin Sylvain]

There is only one way to calculate Cap Rate. NOI divided by Purchase Price.

Net Operating Income is Annual (Income minus Expenses).

And here's where it gets tricky. Income is pretty straightforward, but which expenses do you include?

Actual maintenance and repairs? Planned or expected maintenance and repairs?

Vacancy rates? How much? Actual or expected?

Property management? What if you manage it yourself? (I'd pay myself a salary so it'd be the same)

Capital Expenditures? Actual, pro-rated, planned? (Just how old is that roof anyway?)

Insurance, HOA, Property taxes? (I've seen sellers leave out the property taxes, I think to artificially boost the cap rate).

Utilities? Who's paying, landlord or tenant?

My recommendation is to use a calculator such as "DealCheck.io" or the one on BP. Adjust the options to what you feel is a good way to do things. For example, I always use an 8% Vacancy rate, approximately one month. I use a 2% CapEx for newer properties, and 5% for older ones. (Built 5 years ago? That HVAC will be fine for a reasonable amount of time. Built 50 years ago? I'd be surprised if it's still working tomorrow.)

Once you have the settings where you want them, run all your prospective deals through that same system. Your cap-rate may not agree with anyone else's (I never get the same answer as the seller or the agent) but at least when you compare the deals, you're comparing your apples to your apples, not somebody else's oranges.