Posted by Bill K. (AZ) on April 30, 1999 at 14:29:09:
The first question I would ask is “How did you figure your cap rate?”
Cap rates are determined as follows:
Gross Rents: $36,000
Minus Expenses (about 40%): $14,400
Equals Net Operating Income: $21,600
Cap Rate: $21,600/$165,700 = 13%
While a cap rate of 13% is good, it certainly isn’t 20% as advertised. So, I’m wondering what other information is inaccurate.
I suspect that whoever came up with that “approximately 20%” figure didn’t exclude expenses. When I figure their idea of a cap rate, without expenses, I get 22%. However, that is NOT the cap rate.
The property is being offered at $27,700 per unit. I don’t know anything about “per unit” rates in Philadelphia, but, where I live, this would be quite reasonable.
Keep in mind that, no matter what the seller shows you, expenses will run around 40% of your rents. If he shows you something less than that, you could very well be looking at spending money on deferred maintenance. Of course, since you know that “extensive renovations” have just been completed, you probably won’t run into any deferred maintenance. But, I would still utilize the 40% figure for expenses. Hence, I wouldn’t count on more than $1,800/mo, or $21,600/yr, for your mortgage costs.
If you can get more rent, then the property value increases and your cash flow increases. However, perform your due diligence to make sure you know the real value of the property. Don’t take someone else’s estimate of value. Convince yourself first. Then, you can make an educated determination of what you should to offer.
I hope this helps.
Bill K. (AZ)