Jonathan Cronin explains cap rate as NOI divided by property value, the formula that tells you if a deal hits your income goals. Want $100,000 yearly at 7% cap rate? You need $1.43M in property value. A $4M property generating $200K NOI is a 5% cap, which matters because it shows you what you're actually buying.
Questions this video answers
NOI ÷ cap rate = value (shorthand I ÷ R × V).
Approximately $1,428,571 (≃ $1.43 million).
5% (200,000 ÷ 4,000,000 = 0.05).
Welcome, everybody. Good to see you. Glad to have you with us. Hey, everyone. Hey there. All right, welcome. So for those of you who don't know, we have been talking about expanding out the curriculum, updating it. Lulu, great to have you with us. Good evening to you as well. The curriculum. And so Tuesday nights are now going to be webinar nights to be time for me to teach. And we are taking your high priority questions. And so this week is about cap rates. The cap rates are a common question that I get all the time. And when we put it out to the group, it said, what do you want me to teach on first? Cap rates were easily at the top of the list. There seemed to be a pretty clear consensus that cap rates, that's what everybody wants to, to understand. How do you calculate cap rates? How do you calculate market cap rates? What are cap rates? And because there's a lot of confusion around this issue. But first of all, Shanika, you got it. Got a yay for cap rates. That's how you know we're all real estate nerds if there's a yay for cap rates. Importance of cap rates first. So for those of you who found yourself here and you're like, you know, is cap rates. It doesn't sound exciting. It's math. I often say that the thing that made math exciting for me was when they put a dollar sign next to it. So as soon as you put a dollar sign next to math, now suddenly it's fascinating, right? Because it's your money. This is how you're going to change your life. And I'll just do a quick analysis here at the beginning to show you how you could calculate how much real estate you need to own in order to change your life in order to replace your income in order to be able to quit your job. That's what we're going to dive into. So, for example, let's say I wanted to make a hundred thousand dollars in order to replace my income. So who here could benefit from another hundred thousand dollars a year, right? A hundred thousand dollars. So if I need to make a hundred thousand dollars, sometimes that can be overwhelming. Sometimes it's like, yeah, I'd love to make another hundred thousand, but it's just a dream. I dream of making another $100,000. But remember that the difference between a dream and a goal is a plan. Part of why you're here, REI accelerator, is that we're making a plan. Your coach is making a plan in order for you to achieve your goal. So if $100,000 is your objective in income. And let's just for now to illustrate this, let's take a 7% cap rate. So I want to earn $100,000. We're going to talk about how I came up with that number, why I use 7%. But just to get you engaged, $100,000. Let's say that the market cap rate is 7%. That's not too far off on the truth. So 7%. The cool thing about cap rates is that $100,000 becomes my net operating income. And you are all familiar with this because you're familiar with net income, right? And you're familiar with when you get your paycheck. Your gross is not what you take home. Your take home is your net income. Net operating income is the net income produced by the operations of a business. So it's not that intimidating, right? It's just the net income. Just like a pay stub, the business operates, produces a net income, that net income comes back to you. So net operating income, net income from the operation of a business, we want to earn $100,000 in net income from this business. Then a business or an apartment complex that's producing 7% based on the value of the property would need to be 1.5 million. It's 1. 1,428,571. What Cloud 1.5. So if I own $1.5 million in equity in commercial real estate at a 7% cap rate, I can now quit my job with $100,000 income that I'm making from this property. So that's why cap rates become exciting. That's why cap rates become interesting. Because it's now it's practical right now. It's how much money you need to make in order to have financial freedom. That's where math becomes interesting. Because now we're talking about your portfolio, we're talking about your life, we're talking about your income. So this is a goal and I've had some of you write that down, post it on your bathroom mirror, put it in your wallet, put it on dashboard of your car as a motivating factor. I need to have $1.5 million in equity in real estate that's earning 7% in order to be able to quit my job. So that's my, that's my target. That's my objective right now. Let's talk about how I did that so quickly. How did I figure out cap rate? Just off the top of my head, there is a very important formula that I'd like to have you commit to memory. Now, for now, you're just going to write it down and you'll try to remember it, but over time, I'd like you to commit this to memory. So the way that we put this in shorthand, so if you're taking notes, write down NOI over rate times value. OI over rate times value. Okay? We shorten that up into I over R times V, I over R times V. And it's silly, but the way that I remember this is Irv. I'm gonna go ask Irv how much this property is worth, since we're diving into cap rates today. So I'm going to ask Irv how much this property is worth. I over R times V. And that's just a silly way to remember this formula. But the power of it is, this is what's called a circle formula, which means that if I have any two of these numbers, I can calculate the third. If I know the income that I want to earn, the income that a property is producing, I can take that income and I can divide it. Anytime you cross this line, it's divide. So if I know that a property is producing $200,000 in income and that property is listed for $4 million, then I take $200,000 and I divide it by $4 million, and that's a 5 cap. You follow me? So if I've got a property that's producing $200,000 net income and that property is listed at 4 million, you could just imagine that scenario happened, right? A broker sends you a deal and says, there's a deal that I've got for $4 million, it's producing $200,000 in income, and you can calculate yourself that's a 5 cap. But guess what else you can do? Let's say you're looking at a deal on LoopNet, or you're looking at a deal on Prexi, and it's a $4 million listing, and the broker said, that deal is a 5 cap deal. You can imagine that happening. That happens all the time. I've got a deal that's listed 4 million. It's a 5 cap. Well, guess what you can do? You could take 5%.05 and you can multiply it by 4 million, and you know that the NOI for that property is $200,000.
