let’s talk: CAP RATES & PRICING
Yesterday I was helping a client come up with his after repair value on a commercial flip that he is about to close on and start renovating next week Commercial properties, and properties with 5+ units are typically priced on an income basis. We knew the cap rate we were targeting, 6%-7%, and worked backwards to determine a good list price. Let’s talk about that process.
So, as we do, let’s talk Real Estate, let’s talk UTILIZING CAP RATES FOR PRICING…
WHAT IS A CAP RATE?
Your cap rate (capitalization rate) is essentially your rate of return. How much money you will make on your cash investment. The calculation is:
Net Income / Property Asset Value = Capitalization Rate
HOW DO YOU USE IT TO DETERMINE LIST PRICE?
So here is how we backed into this client’s list price.
Step 1: Deteremine your target cap rate
In the city of Philly we are seeing commercial properties sell with a 6% – 7% cap right now.
Step 2: Define your scope of work
We knew what he planned to do with the property, totally rehab the current the space containing 5x studio apartments, 1x 1 bedroom apartment and a storefront. This layout was based on the current zoning. Rezoning can be $$ and take a ton of time so it was advantageous to stick with what was already in place.
Step 3: Forecast revenue
To help us determine the estimated annual income, we looked for rental comps in the area to determine the rates for each of these units post-renovation.
See my example below (p.s. these are not the actual numbers, all are purely hypothetical for demonstration purposes):
Studio = $1,000/mo x 5 studios = $5,000/mo
1 Bedroom= $1,700/mo
Storefront = $3,000/mo
= $9,700/ mo in revenue
= $116,400 in annual revenue
So we now that we know the annual revenue, we need to look at the projected annual operating expenses.
Step 4: Calculate Operating Expenses
Operating expenses may look like the below:
Real Estate Taxes: ($1,500)
Property Management: ($9,312)
Total Operating Expenses = ($13,612)
Step 5: Calculate Net Operating Income
Annual Revenue: $116,400
Annual Operating Expenses: ($13,612)
Net Operating Income = $102,788
Step 6: Back into property value
Utilizing the cap rate formula, we can back into the list price.
Net Operating Income / Capitalization Rate = Property Asset Value
We mentioned before that we wanted to list at a cap rate of 6%-7% so…
@ 6% Cap Rate = $102,788/.06 = $1,713,133
@ 7% Cap Rate = $102,788/.06 = $1,468,400
Hope this breakdown is helpful to all of my fellow investors out there!
p.s. LET’S CONNECT ON SOCIAL MEDIA
Facebook Page: https://www.facebook.com/ErinHomeandRE
p.p.s. If you are comfortable would you mind leaving me a review?! Would love to know how you are liking this blog or if you have enjoyed working together!
Google Business Page
Zillow Business Page