Figuring Out Cap Rate, What is a Good Cap Rate?
Intro
As an investor, I'm sure you're aware of the critical importance of knowing your numbers. Understanding the concept of cap rate is crucial for real estate investors seeking to assess potential returns on their investments. By examining how cap rate is calculated and what constitutes a favorable rate, investors can make informed decisions about their real estate ventures by reading this article.
Key Takeaways
We will go over the meaning of the capitalization rate
We will explore the formula for calculating the cap rate.
We will understand a bit more about what is a good cap rate.
We will also list a few great calculators.
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Capitalization Rate Meaning?
Capitalization rate or "cap rate" measures or evaluates your potential return on investment (ROI) for real estate. It's Calculated by dividing the property's net operating income (NOI) by its current market value or purchase price.
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Cap Rate Formula: How to Calculate Cap Rate For A Rental Property
The Formula to calculate the Cap rate is as follows:
Cap rate = Net Operating income (NOI) รท Current Market Value or Purchase Price
Net Operating Income
Net Operating Income (NOI) is the total rental income minus operating expenses such as property taxes, property insurance, property management fees, maintenance and repairs, utilities (e.g., water, electricity, gas), property association fees (if applicable), vacancy allowance (an estimation of potential rental income lost due to vacancies)
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What Is A Good Cap Rate For A Rental Property
Generally, a good cap rate would be between 4% and 10%. It's important to note that not all investments will meet the criteria but this does not mean it won't make a great investment. Other factors to consider when deciding if it's a good investment include appreciation and mortgage paydown.
Cap Rate Calculator
Here are three excellent cap rate calculators. These calculators are versatile and can be used for various property analyses.
DealCheck Calculator (This calculator is free with a paid version)
Bigger Pockets Calculator (This calculator has a free trial then is free to paid members)
Omni Calculator (This one is free, but not limited)
For more information on DealCheck Calculator, you might like "Rental Property Calculator"
Outro
Now that you've acquired a more profound comprehension of the capitalization rate, you can confidently navigate future real estate investments. With this knowledge, you're better equipped to decipher the nuances of property valuation and gauge potential returns with greater precision.
Happy Investing!
Check out my Resource Page for some of the top software to help you on your Real Estate Journey
FAQ
Is 7.5% a Good Cap Rate?
Yes it is considered a good cap rate. A good cap rate generally would be between 4%-10% with rates ranging between 5%-10%.
What does 7% Cap Rate mean?
A 7% cap rate simply means that the net operting income (NOI) generated by a property is equal to 7% of it's current market value or purchase price. Example a property generates an NOI of $7000 and is worth $100,000 on the market.
Is Cap Rate the same As ROI (Return on Investment)?
No, they are not the same. Cap rate is to measure the relationship between the Net operating income and its properties' value. ROI on the other hand is a broader measurement that calculates the total return earned on a property including its appreciation or depreciation.
What happens if Cap rate is lower then interest rate?
If the cap rate is lower than the interest rate, it means the property's income isn't enough to cover borrowing costs. This can lead to negative cash flow, making the investment less appealing and riskier. Investors should carefully assess the situation to avoid financial strain.