If you’re looking for a rather simple, rather simplistic method of comparing possible investments, one way to go is to compare the cap rates of different properties. It’s not the end-all be-all measure by any stretch, but it’s enough for making a comparison at a relatively quick glance.
To determine the cap rate of a property, first you need to calculate the Net Operating Income, or NOI …
NOI = annual rent minus expenses (vacancy allowances, repair allowances, operating expenses such as HOA fees, management fees etc.)
Now with the NOI in hand you can calculate the cap rate …
Cap rate = NOI divided by property price
It’s really about that simple.
So going back to the top, which property would make more sense?
The $100,000 house would result in $9,600 in annual rent. We’ll figure 5 percent for a vacancy allowance and 5 percent in other expenses, including the HOA.
$9,600 minus $480 (vacancy) minus $480 (expenses) = $8,640 NOI
Take the $8,640 in NOI, divide by the sales price and the cap rate is 8.6 percent
Now the $120,000 house … annual rent is $10,800, vacancy and operating expenses are $540 each. NOI equals $9,720.
Divide the $9,720 by the $120,000 sales price and the cap rate is 8.1 percent
Easy enough, eh?
Want to try and find real properties here in the Phoenix real estate market to plug into the formulas? E-mail me at info at allphoenixrealestate.com or call me at 602-502-9693 and let’s see what we can find.
P.S. There is a builder in town who is accepting investor offers where the cap rates, based on the base price, is in the high 8s. Just sayin’.