this strategy has been profoundly successful for many real estate investors with enough capital to rent in “hot” locations but without the wherewithal to buy.
Can you use capitalization rate when you are evaluating a property when all the income is generated through Airbnb rentals?
Yes, you can.
Income is income, so the Calculation works.
The Capitalization Rate (CR), referred to as the Cap Rate, is the ratio of the Net Operating Income (NOI) to the Fair Market Value (FMV) of the property.
The Capitalization Rate is your overall rate of return on the value of the asset.
CR = NOI ÷ FMV, where
CR is the Cap Rate,
NOI is the Net Operating Income, and
FMV is the Fair Market Value of the property.
For Example, if you have a $500,000 multi-family property that has a Net Operating Income of $65,000 the Calculation is:
CR = NOI ÷ FMV
CR = 65,000 ÷ 500,000
CR = 0.13
The Cap Rate for this property is 13%.
Investors in a particular market, of for a particular type of real estate investment, don’t actually declare what their Cap Rate is.
But they establish the Cap Rate by their decisions on how much to pay for an investment property that has a specific Net Operating Income.
In the above Example, investors in that market are willing to pay $500,000 for an investment property that has Net Operating Income of $65,000. That consensus among them creates the 13% factor as the market Cap Rate for property of that specific type in that specific price range in that specific market.
The Law of Supply And Demand will create the consensus.
So, you will hear references that say the Cap Rate is such-and-such for this type of property in this market.
One of the values of using the Cap Rate to compare different properties is that the NOI does not include debt service, an expense which will be different for every potential buyer, and using the Cap Rate allows for across-the-board comparisons of just the properties, with the same assumptions applied to each one.
You can use the Cap Rate alone to compare potential investment properties, and you can also use it in association with Cash Flow analysis.
A calculation based on Cap Rate and Discounted Cash Flow might give you even more valuable information.
You can quickly Calculate your Cap Rate with the following Free Calculator.
1. For “net operating income (NOI)” enter 65000 (no comma).
2. For “value or cost (V)” enter 500000.
3. Click “Calculate.”
Your Cap Rate is 13%.
This is the same number that we got when doing it by hand.
You can use one of the other calculations on the page to determine NOI or Value if you already know your Cap Rate.
I hope this helps.
Michael Lantrip, Author, “50 Real Estate Investing Calculations”