Take a close look at a property’s Net Operating Income and Capitalization Rate before buying. 

Most investors are quite familiar with the standard formula in income property valuation:  Value = Income/Capitalization Rate.   Most income properties are offered with a stated capitalization rate.  Sometimes it is based on the owners most recent historical income and expense statement or based on the real estate agent’s pro-forma.  There are some important issues to consider:

• The capitalization rate accounts for the return on and, most importantly, the return of your investment. Thus, the depreciation rate on buildings and buildouts is factored into the capitalization rate.
• Often, the expense of managing a property is not included in a listing’s operating expense proforma (owner managed). Net operating income is overstated as is the cap rate in those instances.
• A buyer should also consider the fact that real estate taxes will likely go up after the sale is recorded.

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