Two calculations many of our client’s use when evaluating income producing real estate are Cap Rate, and Cash on Cash return.
Let’s take a closer look at those two terms in this video:
Over at BenjaminBach.com there is a very good explanation of these two terms:
Cap Rate, or capitalization, expresses the ratio between the net operating income a property produces, and the value. It shows up, based on income, what a typical investor (or ‘the market’) is willing to pay for the income the property produces.
Cap rate = Net Operating Income / Price (or value)
When we’re evaluating properties and we want to determine what we’ll pay for a certain apartment building, we will rework the formula to look like this:
Value = Net Operating Income / Market (or desired) Cap Rate
Cap rate does not take into the financing available, so unless you are buying a property in CASH, that is, without a mortgage, you’re going to want to factor in the cost of debt into your return calculations.
That brings us to Cash on Cash return, which is:
Cash Flow Before Taxes / initial investment
We calculate Cash Flow Before Taxes by:
Gross Rent – owner’s operating expenses – mortgage payments = Cash Flow Before Taxes.
Cash on Cash gives you a more precise return, because it accounts for the cost of the debt we use to purchase the property
For more information about the commercial real estate market in Waterloo Region, contact me today at Benjamin@BenjaminBach.com or call me at 519.772.4376.
KW Commercial is your one stop shop for commercial, investment, retail and multi family advice and brokerage in Waterloo Region
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