The second method that we can use to estimate the sale price for
this property, is called the capitalization rate, or cap rate.
It's extremely important as a real estate finance professional in construction
management, or otherwise to know what a cap rate is, because it's very common.
It's used all the time, okay?
The general concept is, we want to consider the property from the buyer's
perspective, the entity or the person who's going to buy this and
manage it while the the grad students are living in it.
Enjoy the cash flows from the graduate students living in it, paying their rent.
So, that from their perspective, we ask,
what's my annual operating return on equity, okay?
And that's what cap rate is, okay?
That's required to make this purchase viable for me.
All right, so what do we mean, first of all, by operating return on equity?
Okay, in general, in finance if you had a first course in finance,
you probably learned that operating return on equity looks something like this.
Our annual earnings before interest and
tax minus our maintenance capital expenditures on the property.
Maintenance capx means fix the leaks in the roof,
re-point the bricks every now and then, replace windows, as they need replacing.
That sort of thing.
So, our earnings before interest and tax,
minus our maintenance capital expenditures,
divided by the market value of the equity of the entity, or
the project, or the property at the beginning of the year.
So this is annualized EBIT in our first year,
divided by the market value of the equity at the beginning of the period.
In real estate finance,
we just morphed this a little bit into something very similar.
So this is going to be our net operating Income
from the property from APEX In
its first year of operations.
[COUGH] Divided by what we're going to pay for it, okay?
And that's called the cap rate.
And cap rates are always measured in percent, okay?
We have dollars over dollars, so we measure this in percent, okay?
So now, we have another term to define.
What do we mean by net operating Income?
So, net operating income is a very important term also
in real estate finance, and it's defined to be our cash revenue during the year,
minus the set of cash
operating expenses plus maintenance capx, okay?