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CAP Rate, Capitalization Rate & Return On Investment

 

Return on Investment, is used for investment property (ROI) is nothing more than a sophisticated calculation that is applied to a piece of property that you are planning to purchase.

BY APPLYING A STANDARD MEASURING ROD SIMILAR PROPERTIES CAN BE COMPARED.

Now the best property can be selected by applying financial analysis, don't worry there are numerous templates and software programs that will do the more cumbersome cash flows.

ROI is a calculation that will take into consideration all financial matters about your transaction, from the down payment to the expected cash flows.

The best way to understand the complicated formula for ROI into apply a scenario.

To keep this calculations simple we are only going to use one year of rental income and we will then assume the property will be sold with a 7% increase due to inflation
Assume a property is for sale for $1,000,000.00.

The investor is able to put down 30% or $300,000.00

The property will generate a cash flow of $12,500.00 per month

Annual Operating Expenses are currently running at $50,500.00

Property is currently showing a 5% vacancy factor

Annual debt service is approximately $61,000.00.
What is the Return on Investment for our investor?

ROI % is the Cash Flow before taxes divided by total cash invested.

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Gross Rental income = $150,000 (monthly of $12,500 * 12)

Less Vacancy Factor = $7,500.00 (Gross rent of $150,000 * 5%)

Gross Operating Income = $142,500 (Rental of $150,000 - vacancy of $7,500)

Less Operating Expenses = $50,500.00 (given above)

Net Operating Income, (NOI) = $92,000 (Operations $142,500 - Operating Expenses of $50,500.00)

Less Annual Debt Service = $41,500.00 (given above)

Cash Flow Before Taxes = $50,500 (NOI of $92,000 - Debt Service of $41,500)

Return On Investment = 16.83% ($50,500.00 divided by total cash down payment of $300,000) Less Vacancy Factor = $7,500.00 (Gross rent of $150,000 * 5%)

Gross Operating Income = $142,500 (Rental of $150,000 - vacancy of $7,500)

Less Operating Expenses = $50,500.00 (given above)

Net Operating Income = $92,000 (Operations $142,500 - Operating Expenses of $50,500.00)

Less Annual Debt Service = $41,500.00 (given above)

Cash Flow Before Taxes = $50,500 (NOI of $92,000 - Debt Service of $41,500)

Return On Investment = 16.83%
($50,500.00 divided by total cash down payment of $300,000)

   
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