Capitalization rate is used by investors as a quick way to determine which investments are good and which ones are not. Also known as cap rate, it is one of the metrics commonly used in the world of real estate investing.

Experienced investors use cap rate to analyze and compare similar real estate investment properties. Newer investors should learn how to calculate cap rates so that they could make better investing decisions.

Cap rate is commonly used to evaluate both the return on investment (ROI) and the risk in a real estate investment property. It can help investors find good investments and even determine if their current investments are being mismanaged. [1]

What is Cap Rate?​

A commercial real estate property’s capitalization rate, or cap rate, indicates the rate of return or net income that it is expected to generate. Cap rates are used to quickly compare the relative value of similar real estate properties.

Simply put, cap rate is the estimated rate of return on a real estate investment property or what part of your initial investment will return to you every year. For example, if you bought an apartment for $100,000, and the cap rate is 10%, it means that each year, 10% of your initial investment is expected to return to you. [2]

If the cap rate is at 7.5%, then you can expect an annual gross income of 7.5% on the value of your investment property. Cap rate does not include mortgage. This means you can use it to accurately assess ROI on a property. If you include your mortgage, you will be able to find the levered yield.

Keep in mind that cap rates cannot be used as the lone indicator of a property’s value. There are many other factors that should be taken into consideration, including leverage and potential cash flows from renovations and other improvements.

Before going into the formula for calculating the cap rates of multifamily real estate, let us briefly discuss what this particular type of real estate property is.

What is a Multifamily Property?​

A multifamily property is any residential building that has multiple units that can be occupied by more than one family. This includes condominiums, duplexes, triplexes, and apartment complexes. The number of units does not matter. [3]

Multifamily real estate may take many forms. A duplex is the simplest form of multifamily housing because of its two-unit setup within a single building. The term “multifamily” differentiates it from single family homes.

For investors who want to try investing in multifamily real estate, they can do so without shouldering the responsibilities of being a landlord by going into multifamily syndication. With this passive type of investment, you don’t have to manage a property, deal with emergencies, or communicate with tenants.

Multifamily syndication involves multiple investors pooling their money together to purchase a single asset. A syndicator, such as BAM Capital, puts the deal together and looks for investors to join in the syndication. Through multifamily syndication, they can enjoy a passive real estate investment and a continuous cash flow without becoming a landlord. They can also earn money from the equity once the deal is finished. [4]

Investors who want to try multifamily syndication should work with BAM Capital. BAM Capital handles all steps of the investment life-cycle, from purchasing to remodeling to management, yielding a higher return for investors.

Just like other types of real estate investments, cap rate also applies to multifamily properties.

How is Cap Rate Calculated?​

Capitalization rate is calculated by dividing net operating income by property asset value. You just have to subtract the operating expenses from the building’s overall gross income to find the property’s net operating income or NOI. Then, you can divide the NOI by the investment property’s current market value or purchasing price to find the cap rate. This is then expressed as a percentage. [5]

The formula for determining cap rate is net operating income divided by property value. The cap rate is the ratio of NOI to sales price or property value. But investors can use cap rate calculators online to make this process easier.

For more advanced investors, they may include additional parameters such as vacancy rate or the percentage of operating expenses such as utilities, maintenance, and insurance. However, when it comes to operating expenses, this does not include mortgage payments, income taxes, and depreciation. This means the net income is the cash that you earn before debt service and before income tax. [2]

Sources:

[1]: https://medium.datadriveninvestor.com/abcs-of-multifamily-investment-classifications-2fa557cef63f
[2]: https://2ndkitchen.com/apartments/cap-rate-for-multifamily-investments/
[3]: https://gowercrowd.com/real-estate-investing/class-a-b-c-properties
[4]: https://www.omnicalculator.com/finance/cap-rate
[5]: https://www.sharestates.com/glossary/multi-family-property/
[6]: https://www.sharestates.com/glossary/multi-family-property/
[7]: https://capital.thebamcompanies.com/
[8]: https://www.investopedia.com/terms/c/capitalizationrate.asp