Ken Mcelroy is implementing basic algebra to the capitalization rate formula. The formula & the subsequent rearrangement:
Capitalization Rate = Net Operating Income/Asset Cost
*Now multiply both sides by Asset Cost to remove Asset Cost from right side and place it on the left side results in:
(Capitalization Rate)(Asset Cost) = Net Operating Income
*Now divide both sides by the Capitalization Rate to get:
Asset Cost = Net Operating Income/Capitalization Rate
I know most people on the forum understand this, but it may help beginners unfamiliar with the formula.
The problem with the property you've posted:
As Joel Owens notes, the operating costs of 75,000 (17% of gross income) are completely unrealistic. The 50% rule is usually pretty close, but can vary due to the property's age & condition, the amount of work you do yourself (PM, repairs, etc.), and many other factors. For example, it's usually safe to estimate a 5-10% vacancy rate (thus a 5-10% reduction in GI - gross income), 10-20% reduction in GI for maintenance and capital expenditures (major expenses that do not occur every year such as replacing a roof), 10% reduction in GI for property management (if in use), and taxes/insurance/etc. gets us up to the ~50% reduction in GI. The 50% rule helps investors quickly analyze a potential investment due the rule usually being close to the actual numbers.
The analysis is also off because using the given 6% capitalization rate and 359,000 NOI, an investor will not arrive at a 5,983,333 price. The total cost to the investor will include closing costs and potential repairs right after closing.
Also, the Cap rate required by investors will be different in relation to the characteristics, risk and other factors presented by the property. There is not a single cap rate in a local real estate market.
