A cap rate can be very useful in comparing property with other property. It is a very simple form of comparison. It only looks at one year and DOES NOT include debt. It merely tells you the relationship of an income stream to the price without any debt. So, look at it as if you paid cash for the property. After the expenses are deducted from the gross income, you would be left with a net operating income (NOI). By dividing the cash price into the NOI you get cap or the relation of the income stream to the price expressed as a percentage. If you do the same calculation on other properties (assuming the gross income and expenses are accurate equaling an accurate NOI) you will be able to compare the relative return of other properties to one another. As mentioned be cautious on how you use cap but it will give you a "base" from which to compare. I recently took a look at a local MLS for residential income property both active and solds for an article I was writing on cap rates. Most of the lisitings had no expense information at all and those that did all had it incorrect. That is always going to be a challenge when comparing. To complete my article I took an arbitrary expense figure of 25%. The result was the solds had an average cap rate at 6.4% and and actives 3.2%. As you can see the active listings were priced very high (the lower the cap the higher the price) compared to the solds. The highest cap rate for an active listing was 5.4% which was below all but one of the sold cap rates. Naturally if I had used a higher expense factor the caps would have been lower across the board.
Dec 15, 2009