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Step #2: How do I determine a Cap Rate?

A cap rate (short for Capitalization Rate) tells you what the market will bear. The cap rate is the market cap rate at the time you plan on executing your exit strategy, either buying, selling or refinancing. To determine the market cap rate, find the cap rates of three deals that have closed in the last 12 months.

Hotel and Hospitality examples:

• 9,166 SF Hospitality Building Offered at $4,000,000 at a 7.88% Cap Rate in Las Vegas, NV
• 11,264 SF Hospitality Building Offered at $4,175,000 at a 6% Cap Rate in Carson City, NV       
• 9,492 SF Hospitality Building Offered at $2,790,000 at a 9.25% Cap Rate in Reno, NV

Find the average of three cap rates and that’s your market cap rate.

What is a FAST and EAST way to Calculate CAP RATE?

• Property Purchase Price: $600,000
• Market Cap Rate Assumption at time of Purchase: 6%
• Exit Strategy: Sell in 5 years for profit

How do I determine the project value of a commercial real estate property?

To determine the projected value of the commercial real estate property in five years, we need to divide the NOI by the market cap rate.

If the NOI is $50,000 per year and we assume the cap rate in 5 years is going to be down to 5% the formula would look like this: 50,000(yearly NOI) / 5% market cap rate = $1,000,000

The formula would look like this: 50,000 / 7% = $714,000

You can see how this miscalculation can be a costly mistake. Selling at $714,000 means you are probably just breaking even after paying real estate commissions and closing costs.

So, by making a bad assumption you made a $286,000 mistake. This is why it’s so important to know your market and the cap rate; the cap rate that the market will bear not only is important when you buy, but when you decide to sell or refinance.

Again, you must know what your market cap rate is going to be so you can calculate how much money you will make when you purchase or sell your commercial real estate property.

Step #3: Is it true that at Break-even cash flow, a commercial real estate property is still considered good purchase?

The break-even cash flow in commercial real estate determines the point at which the property’s operating expenses plus mortgage payments are equal to the amount of income it produces.

What occupancy level is needed for the commercial property’s cash flow to break even?

With a 15 unit apartment building, what percentage of the total units in the building need to be occupied for all the yearly costs to be covered by the cash flow being produced?

Know when to hold ‘em…know when to walk away!

• If five people move out, will my commercial real estate property produce enough cash flow?
• At what point will I know that my commercial real estate property, whether self-storage units or a motel is producing negative cash flow?
• Knowing the break-even cash flow threshold answers those questions for you.
• How do I prepare myself to evaluate to buy or sell a piece of commercial real estate property, whether it’s a 15 unit multi-family building, retail shop or a strip mall.

How do I determine the breakeven for my commercial real estate property?

Add the annual operating expenses and annual mortgage payments together, then divide by the potential gross annual rental income.

$75,000 (annual operating expenses) + $65,000 (annual mortgage payments) / $200,000 (potential annual rental income) = 0.7

This indicates a 70% breakeven occupancy point. When you have more than 70% of the units occupied, you’re cash flow positive, anything below that and you are operating in a deficit.

EASY AS 1-2-3! As you can see, this third step: breakeven cash flow is just as important as step #1: DSCR and step #2: CAP RATE in order confidently and quickly evaluate commercial real estate properties, whether an apartment complex or an office building!

Why is it important to know the breakeven cash flow for remodeling my commercial real estate property, whether a multi-family building, self-storage units or an office complex?

It is helpful when renovating that you’ll know exactly how many units you need to get done to start cash flowing. Knowing your breakeven cash flow gives you a benchmark of what you need to reach before breaking even and start cash flowing, which enables you to evaluate if it makes sense to improve your commercial real estate property.

Why is it important to hire a reputable Commercial Real Estate Lender such as Trim Financial?

Most lenders of commercial apartment deals do a maximum breakeven cash flow threshold of 85%.

At Trim Financial, we prefer a breakeven occupancy point of 80% or lower.

Anything below the breakeven cash flow threshold is negative cash flow. Remember: NO GO NEGATIVE CASH FLOW!

To quickly determine how to evaluate your next commercial real estate investment­­­