Income Duplexes

Income Duplex – Calculating the Duplex “Cap Rate”.

What is a Capitalization Rate?

Real estate investors looking for income duplexes should crunch a few numbers. One calculation is the capitalization rate or cap rate for short. The cap rate formula gives you a percentage which represents an idea of how long it will take to fully capitalize or pay off your property. This is done by taking the net operating income the property produces and dividing that by the value of the property. The value is either the most recent purchase price of the property or based off a current professional appraisal value; whatever is most accurate. The formula is presented below:

  • Cap Rate =  Net Operating Income / Property Value

What variables make up the Cap Rate?

To properly calculate the formula some variables need to be defined:

Gross Scheduled Income (GSI) – This is the gross amount of annual rental income you would collect if you had 100% occupancy, and if all tenants fully paid their rent. There may be some other income besides rental income that the property produces. If so, add as other income.

  • GSI = (Gross Rent * Units) + Other Income

Vacancy and Credit Loss (VCL) – This is an estimation of how much money will be lost due to vacancies and non payment of rent. This lose is expressed as a percentage against your gross scheduled income. One way to get this estimation is by analyzing similar investment properties and seeing what their average annual vacancy rate and credit loses are for the year.

  • VCL = Gross Scheduled Income * (Lose Rate)

Gross Operating Income (GOI) – This is when you take the gross scheduled income (GSI) and subtract your vacancy and credit loss (VCL).

  • GOI = Gross Scheduled Income – Vacancy and Credit Loss

Operating Expenses – These are the expenses for the operation and maintenance of your property.  Some examples are:

  • Repair and Maintenance Costs
  • Property Management Fees
  • Property Taxes

There is some variability to what makes up this expense, so have the seller define the items and costs that makeup this number. The aggregate is the total costs to run the property. Not all expenses are operating expenses.  This number should not include capital expenditures or other expenses that are not related to the running and operation of the actual property.

Net Operating Income (NOI) – This is the gross scheduled income you can expect from your property minus vacancy,  credit loss, and operating expenses.

  • NOI =  Gross Operating Income -  Operating Expenses

To Recap:

  1. Define the (GSI). (Gross Rent * Units) + Other Income
  2. Calculate the (VCL). (GSI * Loss rate)
  3. Determine the (GOI). (GSI – VCL)
  4. Define the Operating Expenses. (sum operating expenses)
  5. Determine the (NOI). (GOI – Operating Expenses)
  6. Determine the Cap Rate. (NOI / Property Value)

With any property, once you have your cap rate percentage, you must determine if the cash flow of the property meets your investment criteria.

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