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Cap-Rates - What You Need To Know

Tuesday, January 11, 2022   /   by Michael Albertson

Cap-Rates - What You Need To Know

If you are thinking about buying commercial or investment real estate in Vermont, there are a few major items to look at that will help you determine feasibility. Today’s topic is Cap-Rate. What it is, why it’s important and how to calculate. Other upcoming topics we will cover in future articles include how to do your due diligence, documentation the seller needs to produce for you, financing, zoning, whom to hire for help, and red flags to be wary of, to name a few.

There are plenty of profit opportunities available in the commercial and investment real estate market. From buying a small owner-occupied multi-family residence to multi-million-dollar businesses or facilities, the world of commercial and investment real estate can lead to big profits . . . or big problems if you do not do your due diligence. Please keep in mind that we are not financial advisors, but simply sharing information to help you better understand how to calculate opportunities. If you are interested in making an investment as such, you should speak with a financial planner who can outline more details regarding your specific opportunities.

Capitalization Rate

Thinking about buying a multi-family for investment income? Cap-rate is key. What is a cap rate? The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. You need to know this, and your financial institution will definitely want to know this before they even consider granting you a loan. Figuring the cap rate is easy. Here’s how: 

Capitalization rate is calculated by dividing a property's net operating income by the current market value or listed price. A key point here, you must use net income, not gross. This ratio, expressed as a percentage, is an estimation of an investor's potential return on a real estate investment. For example, you desire to buy a four-unit multi-family as an investment. You take the operating income, the rents, (this is your gross income), minus all the operating expenses (maintenance, repairs, utilities if the owner pays, taxes, etc.), and that gives your net operating income. Let’s say your net operating income is $25,000 on a purchase price of $500,000. Now divide the net operating income by the purchase price for your cap rate. 25,000/500,000= 0.05. In other words, your cap rate is 5%.

Now you have a pretty good guide as to how long it will take to pay off your investment and what your annual income will be. In addition, you can calculate how raising or lowering rents will affect your investment. Generally, the higher the cap rate, the higher the annual return on investment. 

Next up, zoning. It can kill a deal or make you a mint. Until then, may all your real estate dreams come true!

If you have any questions about cap rates, purchasing real estate, or would like more information on available investment properties or any real estate issues, please feel free to contact me at any time. My team and I here at Keller Williams Vermont are here to help, you.

Michael Albertson

Commercial & Residential Listing Agent

Strong Will Real Estate at KW Vermont
Cole Elwood
68 Randall St
South Burlington, VT 05403

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