When it comes to a cap rate and IRR, how much do you really know? Evaluating the potentials real estate investment is never an easy task. There are a handful of things you must consider as an investor. The experts at Luxe Crowdfunding are here to inform you of all the details you need to know. We are one of the top real estate crowdfunding sites in the United States. Let our commercial real estate investing experts help you make more money and get a higher IRR.
What is a Capitalization Rate?
The capitalization rate (“cap rate”) is a simple valuation ratio that is determined by dividing the property’s net operating income (“NOI”) by the property’s then-current market value, with the final number expressed as a percentage.
Usually, when there is a higher cap rate, it indicated a more favorable valuation for the buyer. This give it the potential for an expected higher return from that particular property cash flow.
A property’s NOI is generally its annual revenue less its operating costs; these include utilities, maintenance, management and leasing fees, and personnel costs. Expenses related to capital improvements and depreciation are generally not calculated as part of NOI, since these are either extraordinary or non-cash expenses.
What about the internal rate of return?
Top Real Estate Crowdfunding Sites and IRR
Like the cap rate, an internal rate of return (IRR) objective is expressed as a percentage, but importantly it also takes into account the time value of money.
Both cap rates and IRRs can play an important part in making investment decisions, but each of those measures is only as accurate as of the information that’s used to calculate them.
The IRR is similar to the concept of “net present value,” and measures, as a percentage, the return rate earned on an investment during a specific time frame, assuming a reinvestment of cash flows at the same return rate.
The IRR is a more robust tool than the cap rate because, instead of focusing on a single moment in time, the IRR factors in more than just the NOI and purchase price – it also considers financing expenses and NOI objectives, and the value of various factors in view of the timing of the cash inflows and outflows.
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