30 Days of 3.0 – Day 15: Cap Rates & Price
Welcome to Day 15 in our “30 Days of 3.0” series. Yesterday we introduced our approach for integrating DCF analysis into our cash flow statements. Today, we’re going to show you our new approach to handling Cap Rates, and how it affects our new price forecasts.
Cap Rates area very interesting indicator. The formula looks like this:
Cap Rate = Net Operating Income / Price
In prior versions of the app, we calculated new Cap Rates for years 2-10 based on the original price. It turns out, that wasn’t the right way to do it. And this is actually a really common mistake, because many people in the industry have a poor understanding of how Cap Rates work.
Cap Rates only fluctuate within a few decimal points in any given area, because as you raise the revenue, the value of the building (reflected by the price) goes up as well. So the ratios don’t change that much. Obviously, there are exceptions to that rule, and other market factors also come into play with the price.
So we adjusted our algorithm to leverage the list price and the NOI to find the Cap Rate for Year 1, then use THAT Cap Rate and the NOI in years 2-10 to find what the price would be at that Cap Rate. This means that the Cap Rate we display will be constant now, instead of moving from like 5.2 => 13.9 over 10 years, which never made sense.
Being able to calculate the price is the basis for any Returns indicators, and we’ll talk about those more in the days ahead. Tomorrow, we’ll talk about a new line item to track how much you’ve sunk into the investment. I’ll see you then, and as always, I hope you have a fantastic day! :)