A Commercial Real Estate Investors Guide into Cap Rate
Cap rate is also known as capitalization rate or cap. It's the ratio between the incomes from the rent for the year over the price that was paid for the property. So if you make $25,000 in rent from a property every year and paid $400,000 for a property then your cap rate would be $25,000 / $400,000. If you're planning on investing in commercial properties you'll want to understand this number because you'll see it several times when you're looking at property listings. The average cap rate runs between three percent and ten percent.
When you're looking at investing in a commercial property it's important that you understand that you want a higher cap rate. A higher cap rate means that the property has a higher income which will lower the amount that you need for a down payment. Many successful investors use the cap rate to help them stay away from properties that offer little to no income and that have the potential to become a huge risk for them. This also helps the investor minimize his risks which is an important factor for successful investors.
If you become familiar with the cap rate you will be able to find properties that are able to collect more money from the tenants than what you have to pay the bank. This is a great investment as you are not only investing in property but you're essentially not even paying for it! Also the instant profit can be helpful even if it's only a little as you can use it to pay for the building if you lose a tenant.
Another number that can be confusing is proforma which is also known as potential cap. This number is used by sellers when the property has a lot of vacancies. It's used to help capture the attention of the investor. For example if a property is listed for a million dollars and is filled to 90 percent occupancy then the gross income is $90,000 a year with $30,000 in expenses. You can assume that the potential cap is going to be $110,000 a year when the property is at full occupancy in which the porfoma cap would be listed as 11%.
Since the listings can come in three different cap rates for one property it's important to understand how each works and which ones are the most beneficial. You'll need to understand the net cap rate, gross cap rate, and potential cap rate so that you can make the best investment choices.
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