Cap Rates: An Indicator of Value for Investment Property

A big dream for many people, when thinking about planning for the future and how to invest, is to become a landlord or owner of rental properties.  While most are not necessarily interested in handling the day-to-day property management functions, investing in rental properties can be a very successful venture.  

Some people end up owning property that was passed down through family, and end up becoming landlords by default.  Others may convert their primary residence into rental property when they purchase a new home for their growing family.  In most of these cases, the majority of the properties are likely single-family homes, and not necessarily properties that are built as investment vehicles like multifamily properties of 2 or more units.  Due to that, their market value is predicated more upon the comparable sales of similar properties.  This is because a single-family home’s target market in a sale reaches the broadest amount of potential buyers.

In comparison, the multi-family property’s market value is heavily influenced by it’s capitalization rate.  Simply put, the capitalization rate is determined by dividing a property’s net operating income by it’s sale price.  The number that results is the investment property’s capitalization rate.   When considering a sale or purchase of an investment property, this number is a very important consideration.  

For example, if you were wanting to sell a 4-plex in Portland, it would be important for your broker to research what capitalization rate is prevalent in recent sales of similar properties.  Assuming that most similar properties sell with a capitalization rate of 5.0, and the property’s annual net operating income was $50,000, it would be easy to calculate a recommended market value of $1,000,000.  NOI/Cap Rate (represented as a percentage) or $50,000/.05.  

Identifying that capitalization rate and utilizing your property’s net operating income to determine a potential sale price is one of the best ways to accurately price a multifamily investment property, in general.  Obviously, things like deferred maintenance, location, and city zoning changes will play a part as well.  As well as the potential buyer’s and seller’s motivations.

If you have a duplex, triplex, or other investment property, and would like to receive a free market analysis, get in touch with us today!