When most people refer to capitalization rate, or cap rate for short, they are more specifically talking about “market” cap rate. That is a topic for another post, but the cap rate is simply the net operating income (annual) divided by the market price (or value) of a property. Search the blog for market capitilization to learn more. What I want  to talk about today is derived cap rate.     Derived cap rate is more specific to the deal at hand, as it actually takes the current financing climate and individual investor into account. It accomplishes this by blending and breaking the calculation into two parts: lender stake and investor equity, and weighting them appropriately.     To simplify this concept, you calculate the payment of a mortgage at the negotiated terms of this deal for $1. That’s right, one single dollar. That figure is called the annual mortgage constant.    

At this point in your analysis, the process is simple! Multiply your annual mortgage constant X the % of the purchase price being financed, and that gives you the financing cap rate. Then, multiply the annual mortgage constant by the risk adjusted safe rate for the investor (another topic!) to get the equity cap rate.     Add those two together, equity cap rate and financing cap rate, and you have your derived cap rate. BOOM!! Pretty simple right? If this all seems like technical jargon, that’s because this can be a pretty technical business…

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