Updated 08-24-2012
Investors are crowding into the buyer’s market today and they all want to know the same thing: “Is this property going to pay off?”
Any agent can answer this question with two simple formulas:
- the capitalization rate (cap rate); and
- the net income multiplier (NIM).
The cap rate is pure profit — the amount of money remaining after all of the owner’s property expenses are deducted from the gross income produced by the property — expressed as a rate, or percentage. Most real estate investors will have a specific cap rate in mind when shopping for income-producing property. This rate may be realistic or not, depending on the current market.
To find a property’s cap rate, a buyer’s agent must first have the following data:
- gross operating income (GOI) from the property (the rent amounts paid by the building’s current tenants and the scheduled rent amounts for vacant units);
- property operating expenses (taxes, maintenance and repairs cost, etc.); and
- the purchase price for the property.
Having obtained the above information, the agent must calculate the net operating income (NOI) of the property by subtracting all property expenses from the GOI:
GOI – operating expenses = NOI
Next, the agent can find the cap rate by dividing the NOI by the purchase price:
NOI ÷ purchase price = cap rate
Once the agent has found the cap rate, the buyer can decide if this cap rate is high enough and whether the cost of purchasing the property will pay off in the end. If the cap rate from the listing price seems too low, the buyer’s agent can use the inverse of the cap rate formula to find a purchase price more in keeping with his buyer’s desired cap rate.
First, find the NIM; this is the reciprocal of the cap rate. Since a cap rate is expressed as a percentage, or fraction of 100, this can be done by dividing 1 by the cap rate:
1 ÷ cap rate = NIM
Next, find the buyer’s desired purchase price by multiplying the NOI by the NIM:
NOI × NIM = purchase price
What the buyer wishes to profit from the property and what he can realistically expect to profit may be two different things. However, an agent who knows how to find a property’s cap rate and NIM can cut through a jungle of expenses and variables to show his buyer an investment property’s bottom line in minutes.
Remember: knowledge is the key to success in today’s real estate market!
You are correct.
The cap rate is a percentage, not a whole number. Thus, the reciprocal of the cap rate is found by dividing 1 by the cap rate.
For example, if the cap rate for a property is 8%, an agent may write the rate as 0.08 and divide 1 by 0.08 to find the NIM: 1 ÷ 0.08 = 12.5.
The same can be accomplished by simply writing the 8% cap rate as a fraction (8/100) and inverting it: 100/8 = 12.5.
NIM is determined by 1 divided by the cap rate, not 100.
In order to make the sale most sellers and their brokers minimize the expenses and exaggerate the income and seldom include management as an expense. An allowance for vacancy is rarely seen. Buyer inquiries about reserves for replacements are answered in silence or jibberish. There are very few properties that will cash-flow in California, especially if they are encumbered by a mortgage. Finding something that will break even is often considered a great success. Realistic cap rates are hard to come by. I’m not talking about cap rates taken fromthe market. So, who buys these types of properties… someone who is very stupid or who has very deep pockets? I’m talking at least 30 years of negative cash-flow deep.
To Phillip…. don’t worry about it. NIM is net income multiplier. What is a net income margin anyway? Good one!!
Thanks. This was helpful. FYI: NIM is Net Income Multiplier. Try searching “NIM and Cap Rate” for further info.
I assume the NIM is the net interest margin (NIM)
EXTREMELY HELPFUL! THANK YOU!