Bob Nelson – The Cap Rate

Right now, we’re going to talk about the cap rate. Thanks for tuning into the Real Estate Today Podcast.

I’m Bob Nelson, Real Estate Investment Broker with Pacwest Real Estate Investments. Joining me today is René Nelson. René is a very accomplished commercial broker dealing with income properties, and owns Pacwest Commercial Real Estate here in Eugene.

René Nelson: Thank you, Bob. Hey, let’s talk about cap rates and what’s happening with cap rates and how they’re changing as interest rates start to change. So now, we’re going to specifically talk about five units and larger for income-producing property.

Bob Nelson: Right. That makes sense. The real income producers, not a duplex, which I guess is an income-producer, but it’s also a toy investment of sorts.

First of all, let’s take a look at what’s a cap rate. It’s the relationship of what a property is capable of producing if owned free and clear of debt on an annual basis. So, for instance, if the property generated $160,000 of rental income per year, you might anticipate that about 40% of that would be consumed in taxes, insurance, maintenance or repair, management costs, etc. So let’s assume, then, that that leaves $100,000 of income, called “net operating income.”

If you didn’t spend any of it personally, and you left it in the pot at the end of the year, that would be roughly the number that would be there. So, how do I then equate $100,000 of net operating income to value? It’s a think called a “cap rate,” or a “capitalization rate.” You take that number, the $100,000. You divide it by the value of the property.

Now, the value of the property is established ultimately in the market by buyers. It’s what buyers pay, not what sellers ask, to establish the cap rate. Sellers establish a asking price, and buyers establish value. So you look at the trend of what buyers are having pay in order to get that income stream. That called a “cap rate.”

For those of you that understand the stock market, it’s the inverse of the price earnings ratio, and the higher the cap rate, the more productive that investment would be. So, as an example, for that type of income property, in Portland, cap rates are somewhere around five percent. In Eugene, they’re more around six percent.

And why the difference? Well, Portland’s a bigger market, more investors, etc. It’s the way it is. So there’s a spread, then, between each of those communities, and we’ll deal with that in our next presentation.

I’m Bob Nelson, Real Estate Investment Broker with Pacwest Real Estate Investments.

Join Bob Nelson and Marcia Edwards Eugene, Oregon, real estate experts daily at 5:30 on KPNW for the “Real Estate Today ” radio show.