PMI East Bay: Quick Explanation Of A Cap Rate And Why Its Important To You? Call us at: (510) 296-3833 Visit our website: http://www.PMIEastBay.com Hi, my name is Mike Connolly. I am the owner of Property Management Inc. here in Fremont. Our business is managing rental homes. We currently manage about 400 homes, and we've been at it for a lot of years. Whenever I'm talking to an owner about their rental home, I always want to bring up capitalization rate. Capitalization rate, or cap rate, is a snapshot of your rate of return on your rental property. It basically tells you, is this a good investment or not? It's one litmus test that I like to use. What I'd like to do over the next two minutes is just go through a cap rate exercise on a home that I just took over to manage on Foxtail Terrace here in Fremont. The owner just bought the home several months ago, gave it to us to manage, we just leased it about 60 days ago. So let's go through the exercise and determine the cap rate for this home, which is a very simple math equation. First of all, you've got your estimated monthly gross rents. We are leasing the home at 2,290 per month. The estimated yearly gross rents, when you multiply this by 12, comes to $27,480, so that's his gross income per month. Now we have our expenses. Property taxes on this townhouse are 4,800 per year. Your property insurance, 1,100 per year. Then you've got your maintenance, which is approximately 1,000 per year. We've told the owner he can expect four to six maintenance calls per year on this home. It was built in 1984. Then you've got your HOA. This is a big expense. This is 300 a month, or 3,600 per year. HOA covers his water, his garbage, his common area, pool maintenance. There's a lot behind that, and that's why it's a big expense. Then you've got your property management at 7.9%, that's our rate, so that comes to 2,200 per year for us to do all the heavy lifting. Then you've got your vacancy, which is 3%, is what I estimate, so that comes to 900 per year, because you're going to have your home vacant about one month every three years here in Fremont. So you've got your total expenses at 13,600 per year, so you subtract 13,600 from your gross rents, and you come to a number that equals 13,880. This is what is referred to as your net operating income, or your NOI. Now what we want to do is look at the purchase price of the home, what the owner paid for it, because we're going to need that number to calculate our cap rate. He paid 440,000 for the home. Now we're going to take the net operating income, 13,880, and divide it by his purchase price, 440,000, and we come to a number of 3.15. That is his cap rate, just a little over 3%. I would call that, in today's market, a fair to good cap rate. I call 2 to 3% fair, 4 to 5% good, and 5 to 8% excellent, so the higher the cap rate, obviously the better return. You're looking for a higher cap rate, but along with higher cap rates, you're going to have more of a risk. A home like this, here in the East Bay has a very low risk, has a low potential vacancy factor, and that's why you have a lower cap rate, but it gives you a snapshot of what your investment is like: should I hold it, or maybe sell it, and possibly look for a higher cap rate somewhere else? PMI East Bay 39111 Paseo Padre Pkwy Fremont CA 94538 (510) 296-3833 http://www.PMIEastBay.com

• published: 24 Oct 2017
• views: 2