Say you just received a call from an apartment complex owner that is considering having you sell his property but would like you to suggest the property’s fair market value and listing price. What do you do next?
In this article we will show you how you can use the cap rate to make that determination quickly and easily.
To begin with, you must establish what the average capitalization rate is in your local area based upon recent sales for similar properties. Since you will be using this “average” to compute a fair market value for your seller’s property, it is very important that you have a clear understanding of what this means.
Foremost, you want to be certain that the “average rate” reflects the same-type of income properties. That is, you want it based upon recent sales of apartment rental properties, not upon the recent sales of office or industrial complexes. And secondly, you must be certain when reviewing the sold listings that any cap rates indicated reflect reliable income and expense data and not simply a listing agent’s hyperbole.
The idea is accuracy. You certainly don’t want to suggest a fair market value based upon faulty data that might result in an over-priced listing you waste your time on, or worse, an under-priced listing that could alienate your seller.
Okay, let’s take it step-by-step so you can follow through and advise your seller what you consider the fair market price for his apartment complex should be.
Determine the Average Rate
The first thing you want to do is to settle on the average cap rate apartment rental properties have recently sold in your market area. We will assume that you were able to obtain this from a local appraiser and are comfortable using 8.0%.
Confirm the Subject Property’s Data
Next, you must validate the income and operating expenses your seller is telling you that his property produces. This establishes an accurate net operating income (income less expenses) for your calculation. We’ll say the net operating income is $41,500.
Make the Calculation
Okay, now divide the net operating income by the capitalization rate to compute the fair market value for your seller’s rental property.
Value = Net Operating Income / Cap Rate
$41,500 / 8.0% = $518,750
