The Internet Real Estate Center

If you're new here, you may want to subscribe to my RSS feed. Thanks for visiting!

Lately, I have been seeing a lot of listings (either on the MLS or other miscellaneous listing sites) that discuss Cap rates on single family homes.  After seeing Cap rates advertised for single family homes, duplexes and four-plexes, I feel that I have to make a comment about Cap Rates and their application to single family investments. 

So here it goes… The use of Cap Rates is inappropriate for single family investment properties. Cap Rate is used for commercial properties in an equation to determine value based on a given commercial property’s net operating income.  Single family homes, duplexes, triplexes and four plexes are valued based on a market comparison approach, not income approach.

Here is the equation:

Net Operating Income / Cap Rate = Fair Market Value

Net Operating Income = Effective Gross Income (After Vacancy) - Operating Expenses (excluding debt service)

An appraiser will go to market researching comparable sales to make a determination of market cap rate. Comparable Sales will have known Net Operating Incomes and known purchase prices. The equation can be changed to find Cap Rate as such:

Net Operating Income / Fair Market Value = Cap Rate

He will then apply the market cap rate in the equation to the subject property’s Net Operating Income to obtain Value.

The key here is that Net Operating Income is tied directly to Vacancy. Increased vacancy produces decreased Net Operating Income which in turn can result in lower value at a constant cap rate. With single family properties you are either 100% occupied or 100% vacant. When you are 100% vacant the property still has value.

Valuation of Single Family homes is weighted toward comparable sales. Income is not included. In commercial real estate three approaches are used to value a property:

• Sales (Market) Approach
• Income Approach
• Cost (Replacement) Approach

The appraiser will weight the approach based on market conditions.  Cost Approach is not often considered in the appraisal.

That’s my two cents worth and I am sticking to it.

Go Here For more information on analyzing commercial properties.

To Your Success

Mark Schwartz

Real Estate Technology Blog
The Internet Real Estate Center
Submit Your Link Exchange Here