Real Estate

let’s talk: CAP RATES & PRICING

Hey Guys!

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:

Insurance: ($2,500)

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! 
 
HAPPY WEDNESDAY!
Erin 


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