 Sellers Tips Part three of this series looked a deriving fair market value using the gross income. The Cap method looks at net operating income.
Operating Expense 1. Property Management fees2.Any legal and accounting fees 3. insurance premiums 4. Maintenance and supplies 5. Utilities Cap Rate: A capitalization rate (or "cap rate") is the ratio between the cash flow produced the building and the price paid to buy it. The rate is calculated as follows:
Annual cash flow / Sales Price = Capitalization Rate
For instance, if a building is purchased for a $1,000,000 sale price and it produces $100,000 in positive net cash flow (the amount left over after fixed and variable costs are subtracted from annual gross rental income) then:
$100,000 / $1,000,000 = 0.10 = 10%
The asset's capitalization rate is ten percent. Capitalization rates are a measure of how fast an investment will pay for itself in net cash flows. In the example above, the purchased building will be fully capitalized (pay for itself) after ten years. Wikipedia
To derive at the cap rate: See Part two of this series to understand NOI.
net operating income / asking price = cap rate
Compare the cap rate here to similar properties in your area. The cap rate will be fair or higher or lower than similar properties If the cap rate of the property seems high the way to determine the right price is:
net operating income / market quoted cap rate = New estimated price
This exercise will give you a market price closer to what the market price is for like properties that are similar. This is a pricing mechanism that is generally used for four units or more. The GRM is the pricing mechanism used for single family homes and investment properties up to four units. Single family homes do not produce cash flow and so are not evaluated as an income producing investment. The net income approach like the GRM approach makes some assumptions that need to be corrected. NOI does not consider the buyers true rate of return. Changes in costs such as property taxes, closing costs and possible higher insurance premiums should be considered before a buyer makes an offer. REsourced from www.yourpropertypath.com You may republish this article, as long as you do not edit and you agree to preserve all links to the author and www.yourpropertypath.com
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