Real Estate Property Valuation - Cap Rate Method

1. Calculate the cap rate. The cap rate is a ratio between the net income of the property and its original price or capital cost. It is calculated as Cap Rate = the annual net operating income / cost (or value)
   
   
   
2. Understand how cap rate can be used by the investor. The investor can start with her desired rate of return and then use the cap rate to establish the asking price of the investment property. For instance, if the investor wants to generate a net income of $10,000 for year one, and wanted an 8% cap rate, then the asking price should not exceed $125,000.
   
   
   
3. Example: An investor purchases a home for $40,000. It is currently rented for $750 per month ($9000 per year). There is a 10% property management fee, $710 in taxes, $650 for insurance and figure 5% for maintenance.
   
   $9000 (gross income)
   -$900 (property management)
   -$450 (maintenance)
   -$710 (taxes)
   -$650 (insurance)
   =$6290 (net income) / $40000 (purchase price) = 15.7% cap rate