Introduction to Real Estate Property Investments
Think of real estate investment as a game where there are plenty of options for you choose from. The real estate market has many different types of homes and structures that you can purchase ranging from duplexes, single-family units, apartment complexes, commercial buildings, strip malls and so much more. With so many options comes many ways in which you can invest your money. You can purchase and flip homes or buy and then hold the homes, for example. Below is an example of how you can make an investment in apartment complexes and reap the lucrative returns that it yields.
The value for an apartment complex is very objective compared to that of a single-family unit. Thus, its value can be calculated using an equation: PP= NOI ÷ Capitalization Rate
Purchase Price (PP)
Net Operating Income (NOI)
Capitalization Rate (CAP)
The property’s CAP rate is equal to its NOI divided by its purchase price. In general, the risk is higher if the CAP rate is high. The reverse is true as well. A lower CAP rate means that there will be a greater change in the NOI on the property’s value.
Adjusting the NOI on a property will exponentially decrease (or increase) the property’s value. Confused? Let’s look at an example. An investor paid $1.6 million for an apartment complex. The CAP rate is 6%. Calculate the NOI. Here is the equation:
NOI = CAP rate X $1.6 million (purchase price)
NOI = .06 X 1,600,000
NOI = $96,000
Makes sense, right? Now, if a 5% increase in rent is allowed by the market (assuming that all expenses remains the same, of course), the NOI increases to $100,800. This is an increase of $4,800 ($100,800 – $96,000). That’s a great increase, but the thing to note in this example is how the $4,800 will increase the property’s value: $4,800/.06. At the 6% CAP rate, adding on the extra $4,800 just increased your property’s value by $80,000!
This is only a simple example to demonstrate the relationship between the property’s income value, its CAP rate, and the NOI. Effective management and planning can significantly increase a property’s value. A similar principle can be applied towards other types of purchases in real estate investments.