Investment Property, It's all about Income and Cap RatesBy Barrett Niehus http://www.freetrainer.com
When looking to buy a piece of property, one must determine exactly what your expectations are for that bit of real estate. What mix of rent and real property appreciation do you expect with this investment.? More importantly, what is right price to pay for this investment?
This last question is certainly most important because it will determine difference between a good investment and a waste of money. If you invest wisely and get a good price for a piece of property, you may expect revenues of 18% and with capital gains in hundreds of thousands. Conversely, if you pay too much, you may end up paying into a losing investment for rest of your days.
Probably most common, and therefore effective, method to value an investment is through use of a cap rate. Precisely defined, cap rate is net operating income of property divided by its purchase price. It shows expected percent annual return given a specific investment. The benefit to using a cap rate is that a buyer can determine his or her expected revenue from investment, and define what a prospective investment is worth. This effectively eliminates random pricing of real estate and reduces determination of sales price to a simple investment calculation. Instead of questioning whether an investment in a piece of property is a good decision, a cap rate can be used to determine what expected return is, and if investment will be profitable.
Another benefit of using cap rates to value property is in resale assumptions surrounding investment. When you value a property as an investment, you must assume that person that will eventually purchase that property from you will be looking for a similar return on their investment. If you are purchasing an investment property and plan to hold onto it for a fixed number of years, cap rate can be used to determine resale value of property in addition to your expected annual return.