Cap Rate vs Cash on Cash Return

I had a seller (who was selling an apartment building in a smaller Alberta town) ask me to help him with a financial breakdown on his condo unit. I came up with the following breakdown.

Revenue \$1250 x 12. = \$15,000
Less: Vacancy 4.55%. =\$ 682.50
:::::::::::::::
Gross Operating Income = \$14,317

ANNUAL EXPENSES
Annual Property Taxes: \$1,489
Annual Sewer/Water: \$300
Property Management. \$0
Repairs and Maintenance \$500
Condo Fees \$125 x 12 \$1500
::::::::::::::
Total Expenses. \$3829
-------------------------------------------------
Net Operating Income. \$10,488

\$10,488
------------- = 6.56%
\$159,900

He replied back and asked if I would consider a different approach. He said that if we add in a down payment of 30.000 = Mortgage of 130,000.00 at 3.75 =768.80 ( 20 year amortization) then it should look like this....

Apartment Rental \$1250 x 12. = \$15,000
Less: Vacancy 4.55%. =\$ 682.50
:::::::::::::::
Gross Operating Income = \$14,317
ANNUAL EXPENSES
Annual Real Estate Taxes: \$1,489
Annual Sewer/Water: \$300
Property Mgmt/ Realtor \$0
Repairs and Maintenance \$500
Condo Fees \$125 x 12 \$1500
Mortgage interest year 1 \$4820
Total Expenses. \$8649

Net Operating Income. \$5668

\$5,668
------------- = 18.89%
\$30,000

In his scenerio, we aren't calculating Cap Rate. A Capitalization Rate is the ratio between the net operating income produced by an asset and its capital cost (original purchase price). Every investor wants to know the cap
rate.

What he has calculated is a Cash on Cash Return, which can be swayed any way you like. In my opinion, agents can't and shouldn't show cash on cash returns in advertising, because we don't know the buyer's financing or tax
situations, so the calculation is often useless, and can be misleading.

A cap rate can only fluctuate if a) the price drops, b) the expenses drop or c) the income increases.

I'd love to hear your thoughts.

Bob Sheddy
Broker/Owner
Century 21 PowerRealty.ca
BobSheddy.ca