Capitalization Rate
Posted by Blue Horizon Realty on Tuesday, March 24th, 2009 at 8:08pm.One of the traditional ways to measure the value of an Outer Banks investment home is capitalization rate. Capitalization rate is simply calculated and can be an invaluable in comparing similar or dissimilar properties. Capitalization rate or "Cap Rate" is found by taking the homes annual net income and dividing it by the cost. For another explanation, here is Wikipedia's definition. WikiPedia: Capitalization rate (or "cap rate") is a measure of the ratio between the net operating income produced by an asset (usually real estate) and its capital cost (the original price paid to buy the asset) or alternatively its current market value.
Using Capitalization rate to compare Outer Banks investment homes
Home #1
Annual gross rent: $15,000
Listed Price on OBX MLS: $300,000
Capitalization Rate: 5%
Home #2
Annual gross rent: $25,000
Listed Price on Outer Banks MLS: $350,000
Capitalization Rate: 7%
Home #3
Annual gross rent: $125,000
Listed Price on Outer Banks MLS: $1,350,000
Capitalization Rate: 9%
As you can see, this is an effective way to compare homes that are going to generate an income. As you can see the overall price is not as important as the amount of income. When using "cap rate" to compare like properties it is also necessary, especially with vacation homes, to check all the variables. Did the current owners have the home open year round or did they only rent it part of the time? Were the rates in line with the going rates for the subdivision? There are of course many additional questions to ask after using cap rate, but it is an effective way to find the homes that are currently the most profitable.
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Posted on Friday, May 29th, 2009 at 8:29 AM.