All Phoenix Real Estate.Com

Phoenix Real Estate and Homes for Sale | Jonathan Dalton, Realty ONE Group – (602) 502-9693

602-502-9693

Phoenix Real Estate Investment Primer – Cap Rate

Phoenix Real Estate Investment Primer – Cap Rate

Which piece of Phoenix real estate makes more sense from an investment standpoint – the $100,000 house collecting $800 in monthly rent or the $120,000 house collecting $900 in rent?

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’.

Comments

  • Jeff Swenson says:

    Cap rates are not a significant factor at all in renting out a single family home.  That cap rate talk is reserved for apartment/multi family property investors.  As all these newbie single family landlords are going to find out the hard way – decent tenants are always in short supply.   And a extra couple of weeks of vacancy or unpaid rent wreaks havoc on your ridiculous “cap rate” math.  As neighborhoods are now getting saturated with rentals the new landlords are may have to lower there standards a bit.  But that’s not our problem right? Keep up the good work encouraging folks with your “investor” talk.

  • Jonathan says:

    Jeff,

    > As neighborhoods are now getting saturated with rentals the new landlords are may have to lower there standards a bit.

    Now getting saturated with rentals? Have you happened to look at the rental market now as compared to say even a year ago, much less two years ago? There hasn’t been a shortage of rental properties for seven years; having said that, there has been a shortage of rental properties available for the past 18 months. Ask anyone who has been searching for a place how easy it is to find a rental right now.

    A 5% vacancy rate represents a full month empty. Average days on market for the more than 6,000 detached homes that were leased out since the beginning of May was 35; For the just under 4,000 homes that have rented since June 1, the average DOM is 34 days. Median days on market in both cases are lower by a full week.

    Naturally, an extended period vacant can change the numbers. So can a higher repair/expense cost – and it will be higher, as I was using very, very basic numbers solely to illustrate a point.

    And that point is this is one calculation than can help someone compare one property to the next in rather short order. Seems to have worked well for my long-time mentors who have about 70 years combined experience in the business.

    If you have an actual substitute suggestion, as opposed to “you suck for writing the definition of a cap rate”, feel free to share it.