The following Q&A was completed as part of our conversational Commercial Real Estate FAQ Interview Series, we hope you find it helpful.
While common, using the cap rate formula alone is often one of the biggest mistakes many make when valuing commercial real estate investments. Your cap rate isn’t always going to equal your rate of return, and it doesn’t always equal the true value of the real estate you’re investing in. Utilizing different methods to calculate your rate of return can provide a more accurate picture of value.
Richard Wilson: What is a common mistake when it comes to multi-family commercial real estate valuation?
Brian Burke: The most common mistake is simply using that cap rate formula, and people will often times say “I want a 10% return.”, so that’s a 10% cap rate. So, if the property generates $100,000 of income, it’s worth $1 million because that’s a 10% cap rate. That’s absolutely the wrong way to approach the valuation of commercial real estate. The cap rate does not necessarily equate to the rate of return you’re going to receive, nor does it necessarily equate to the value of the real estate.