Using capitalization rate to determine income property value and profitability is popular amongst those who work with real estate investment property for two reasons: It reflects the net operating income (gross operating income less operating expenses), and it is easy to compute.

As a result, capitalization rate (or cap rate) is regularly used in two rental property scenarios: To determine whether a property meets with a buyer’s investment goal, and to determine a property’s value based upon cap rates for similar properties in a given area.

Before we look at our examples, consider the formulas

Capitalization Rate = Net Operating Income/Property Value

Property Value = Net Operating Income/Capitalization Rate

Let’s say a real estate investor wants you to locate several multifamily properties priced at about $500,000 with a cap rate of 8.0%. You find two properties listed at $490,000 and $510,000 (so far so good). However, neither listing agent was kind enough (or knowledgeable enough) to include a cap rate.

Your next step is to see whether the agents show the listed property’s net operating income. Again, no such luck, thus requiring you to call the listing agent and ask for the net operating income. If you get a silent response, ask for the income and operating expenses and compute the net operating income yourself.

Several phone calls later, you determine that the property listed for $490,000 has a net operating income of $40,000, and the other at $510,000 of $43,000.

Okay, now you’re ready to compute the capitalization rates. In each case, divide the net operating income by the sale price. $40,000 divided by $490,000 equals 8.16%, and $43,000 divided by $510,000 equals 8.43%. Guess what, you have a match; both properties meet the investor’s cap rate and can be considered of interest.

In this next situation, let’s say you’re preparing a listing presentation and want to advise the owner of a commercial office complex what the property is worth based on similar properties in the area. You’ve already established (because you asked the owner for the property’s income and expense statement) that the net operating income is $65,000.

Several hours later, you determine that a few comparable properties sold within the past six months at an average cap rate of 7.0%, and a few more are currently on the market at around 6.8%. You decide on a cap rate of 6.8% to establish the value of the owner’s office complex.

In this case, divide the net operating income by the capitalization rate. $65,000 divided by 6.8% equals a property value of $955,882 that you round up to $960,000 and present to the owner.

by Bill McCann

Editors Note: ProAPOD is just about to release two updates for its real estate investment software and real estate investor software solutions. Current users of ProAPOD of either of these two real estate investing software solutions are in for a surprise. In the meantime, we are glad to refer this interesting article about commercial real estate written by another.

Most people hear the word “real estate” and their immediate thoughts turn to the dropping housing prices and the subprime lending woes that have made recent headlines. Yet, as the housing market teeters and the “easy credit” of recent years dries up, many have forgotten that a very different story is unfolding in commercial and investment real estate markets. It seems likely that certain trends will affect both of these distinct marketplaces–and it may be for the better.

Tightening Lending Standards
First and foremost, one fuel increasing the values of all types of real estate has been easy access to credit. Short-term variable interest rates have enabled buyers of all kinds to readily obtain loans for sharply escalating property values–an effective bet for the borrower, and ultimately lender, for continued appreciation.

Lending for investment properties, especially income producing properties, has tended to be more focused on the underlying net revenue with less emphasis on the credit worthiness of the borrower, making the default rate on commercial properties lower than that on residential properties. However, our belief is that the market for commercial mortgages is going to improve once folks stop overacting to the current subprime situation.

The Positive
This tightening of standards may offer some positives in terms of buying commercial real estate. In the multifamily sector, it may point to a continued improvement in occupancy and rental rates. Many markets are seeing their first “up-tick” of rents in years.

Also occurring in the wake of the current market is a reassessment of risk, not only for lenders but property buyers. Up until very recently, a single-purpose, single-tenant property has been selling for nearly the same price as a multi-use, multi-tenant property. The faulty reasoning of this lies in the fact that, in terms of risk premium, these properties are not nearly valued the same. Here’s an illustration:

When a person buys a single-purpose, single-tenant property, such as a Walgreen’s Pharmacy, they are centering their risk on location, with one business model, and one tenant. As opposed to a multi-use/tenant property such as a retail shopping center. So if, for instance, retail pharmacies go out of vogue, the owner is toast because that building can only be used for a single purpose. These single tenant properties (commonly called NNN or “triple net” properties) were sought after for their apparent steady cash flow, however they sold for much less than the superior multi-tenant, multi-use facilities in the same market.

Now that we’re reassessing the market, we’re finally taking a look at risk premiums, which forces buyers to look at purchasing property in a different light. In the past, buyers were not getting rewarded for taking on substantially more risk in a property acquisition, but now the higher the risk, the more likely they’re going to get paid more, and vice versa. If this reassessment of risk premium continues, the market will no longer “carry” the inferior property with a modest price difference; instead, it will trade with a notable discount.

The Forecast: A True Flight to Quality
In light of this risk premium reassessment, many predict there’s going to be a progression to “quality” in the commercial real estate market. Whereas a real estate buyer who was contemplating a 1031 exchange might be willing to accept a single-use, single-tenant taco stand just so they could complete their exchange, will no longer be willing to take such a risk. The value of a single-purpose, single-tenant asset would no longer be comparable to the–now more highly valued–multi-use, multi-tenant asset.

The Midwest Market: What’s wrong with stability?
Money from outside the state is still very much a factor to the core business assets within the Twin Cities, specifically within the CBD and outlying solid income-producing properties. This is because the Twin Cities market offers stability. It’s a stable economy, it’s a stable, educated work force, and though some folks might consider this to be a negative, I’m led to ask, “What’s wrong with stability?” Stability often means security, which in a lot of ways is a very positive thing–especially when it comes to securing one’s purchase.

The properties themselves have not wildly appreciated like they have in other parts of the country, so the Midwest hasn’t experienced deep swings in property value or in the income the properties are producing. In addition, occupancy rates remain steady and have not varied much through the past couple of economic cycles. One may not see double-digit annual appreciation in these types of properties, but they are not going to lose their shirt either.

Overall the Midwest has seen similar trends. Minneapolis is a smart, desirable market with a high-quality of life. The market as a whole has been quick to absorb new spaces and my belief is that space will continue to be absorbed without emptying out other buildings. Jobs and new companies will fill up the spots, and the tightening of standards as well as the new assessment of risk premiums will only continue to do well for the commercial real estate of this region. The commercial real estate story is different, and positive. Stay tuned!

More information available at Spectrus Group

About the Author

William (Bill) McCann is Spectrus Real Estate Group’s Midwest Regional Vice President of Sales. Based in Chicago, he is responsible for developing and maintaining Spectrus Group’s position as the leading provider of quality, diversified real estate investments in the Midwest markets.

by Zola Mathe

Editors note: ProAPOD is just about to release updates for its real estate investment software 7.0 and real estate investor software 4.0. The hours of work invested in both these real estate software solutions, of course, has limited the number of original real estate investing articles we have been able to publish. In the meantime, you should get a lot of helpful information in the article below.

In a 1031 Exchange an investor sells his property, called “Relinquished Property,” to acquire a “Replacement Property” without attracting tax on capital gains. There are as many reasons to seek a 1031 Tax Deferred Exchange as there are investors, but the fact is that completing such a property exchange can save you a significant amount of capital gains tax when you decide to sell your existing investment property and to acquire another one. A long established section in the federal tax code, section 1031, allows real estate investors to sell property that has been held for investment purposes and defer capital gains and depreciation recapture taxes if they acquire “like kind” exchange property of equal or greater value and reinvest all of their equity.

Keeping in view the basic idea in mind, 1031 Exchange helps the taxpayers in most of the ways to sell income, investment or business real estate and property and replace with much better like kind replacement property without having to pay federal income taxes on the transaction. When the Exchange 1031 talks about the Investment property it includes all sorts of real estate, improved or unimproved that have been held for the investment or income producing purposes as part of the business or any side income. Anyone who is looking to get its real estate exchanged but has a Relinquished Property that is qualified by the exchange, the properties that are qualified for this purpose includes held for investment purposes or used in a taxpayer’s trade or business.

The foundation of 1031 exchange rule is that only properties held for productive purpose in a business or trade or for investment purposes qualify for a 1031 exchange. The foundation of 1031 exchange rule is that the properties involved in the transaction the property to be sold and the property to be bought must both be held for productive purpose in trade or business or as an investment and they must be like kind. To qualify for a 1031 exchange, both the relinquished property and the replacement property must be held for investment or for productive use in some business.

Some very basic things that one should understand about 1031 Exchange are that only business and investment property qualify for the tax deferral under Section 1031. While IRS Section 1031 allows any US investment or business real property to be replaced tax free with any other investment or business real property anywhere in the United States, there are states that do not recognize 1031 tax exchange. Currently, it is our understanding that the only two states that do not recognize 1031 tax exchange Georgia and Mississippi will only honor the tax free status of a 1031 exchange if the replacement property is also located within their borders.

It is often seen that most people interested for a 1031 exchange into a Tenant in Common property commit certain basic mistakes that jeopardize the whole transaction or results in a complicated legal situation leading to the client paying a huge tax or penalty amount. Because of all these restrictions and rules, 1031 Exchange has a lot of value for anyone who is looking for deferral strategies to avoid paying tax against the exchange of property and other stuff. 1031 Exchange has a lot of value for anyone who is looking for deferral strategies to avoid paying tax against the exchange of property and other stuff.

The 1031 tax exchange has a lot of value when it comes to the gains by not paying capital income taxes, it can in one way help you exchanging the property at a better place without much hassle, no cash transactions and no tax deductions, which in return helps you in starting a cash flow with better exchanges. A 1031 Exchange allows sellers of some real and personal property the opportunity to avoid paying capital gains taxes (which are 15% plus state taxes) by “exchanging” their sold property for newly purchased property. The most difficult part of 1031 exchange is the identifying of replacement property by the investor within a period of 45 days following the sale of the commercial property.

Also, knowing the types of property that can be exchanged under a 1031 will help property owners find replacement properties in a changing market place. Avoid these common mistakes while planning your investment for 1031 exchange into Tenant in Common properties and you can ensure a continuous flow of monthly income while your investment experience a steady growth.
About the Author

Zola Mathe recommends you visit 1031 exchange for more information on http://www.allwiseinformation.com/All_1031_Exchange_Information.html