This is the standard evaluation method used by lenders and appraisers to establish the market value of investment real estate. It usually does not apply to single-family homes or duplexes. It is the most accurate way to value commercial real estate, including 4 unit or larger apartment complexes. Basically the capitalization rate is the "net operating income" divided by the purchase price of the property. To establish "net operating income" first tally up the total annual income then subtract all of the expenses. Expenses will include non variable expenses such as property taxes, and insurance, and variable expenses such as; lawn care, snow removal, water and sewer charge, refuse, utilities, maintenance, repair, long term capital improvements, property management and vacancies. Calculating the capitalization rate requires a recent history of the income and expenses. It also may require reliable estimates of future expenses and income. To be accurate, it must be complete, reliable information.

When arriving at the capitalization rate you will be able to determine if the property is profitable. Generally speaking, the cap rate is considered to be too low to earn a profit it it does not exceed the cost of borrowing money to acquire the property. Everyone has a different expectation of what is a good and fair profit. I have found most deals begin to make sense when the cap rate exceeds the cost of borrowing by at least two points. There are many exercises to learn to be good at figuring cap rates. I am always happy to chat with someone about them if they need an opinion. Just give me a call!