How do you determine the appropriate CAP rate for your area?

When you are buying a property, you want to make sure that you are going to make a profit. However, if you are looking at 4 different properties, it is very difficult to compare them apples to apples. Especially when you have a peach, a pear, and an orange. The only way to compare properties is with the CAP rate. The CAP rate breaks down how much potential profit a property has. This way you can compare the properties equally.

How do you determine the CAP rate. The first thing that you are going to do is you are going to ask the seller for a profit and loss statement. But you don’t want to take their word for it. They may provide you with a proforma of what the property could do, not what it is actually doing. In order to find out what is really happening with the property you need a copy of their rent rolls. You need to know how much income the property brings in. However, you also need a copy of their taxes to know what expenses they have with the property. This way you can see or create a real profit and loss statement.

Once you have determined the real net operating income for the property, then you want to create your own pro forma. You need to know what the property is doing today so that you don’t pay too much for the property, but you also need to know if there is an upside potential. The only way to do this is to find out if the current owners are charging market rents. If they are under the current market, then you will be able to gradually raise the rents up to market value. This will increase your gross income without increasing your expenses. This will increase your bottom line and help with upside potential.

Another thing that you are going to look at is the occupancy rates. What is the typical occupancy rate for that area? Is your property at that occupancy rate or is it a little low? If it is low, why is it low. Does it need some cosmetic work? Is there a bad manager? Are they advertising and marketing to get new renters? If you are able to increase the number of renters that you have, this will also increase your net income and provide upside potential.

Once you know what the current net income is and what the potential net income is, then you can determine how much to offer for the property. You can also determine which of the properties is the best opportunity for you! The CAP rate allows you to look at substantially different properties and still be able to compare them to know which one you want to make an offer on. If you don’t know what the CAP rates are in your area, call your local commercial self-storage Realtor to find out. Then you can determine if that works with what your investment model is. If it doesn't, keep looking. As always, happy investing.