How to Calculate Your Cap Rate
Real estate investment is full of technical terms—and the “cap rate” is one of them. This is a shortened version of the “capitalization rate”, and is simply an approximate way of determining if a property is worth investing in.
However, it’s important to understand that a cap rate only gives an idea of the potential that the property might bring in as an investment—it’s not a figure set in stone. But hey, even the best-laid business plans are only a viable assessment of the art of the possible. So, if you’re right at the beginning of your property investment journey, don’t let this put you off.
Understanding what it is and How to Calculate Your Cap Rate
- What is a cap rate?
- The easiest way to calculate your cap rate
What is a cap rate?
A cap rate is a number that determines a property’s potential revenue and is displayed as a percentage. The higher the number, the more money it should bring in. But it also represents a higher risk. However, the lower the number, the longer it will take to recover the initial investment. This means that it’s a
A good cap rate for an investment property is anywhere between 5-10% (or slightly outside these parameters, in certain situations).
The cap rate is determined by dividing the net operating income (usually abbreviated to NOI) by the fair market value of the property. While this provides a very important insight for understanding its potential return, it’s not the only one. You should also research other property investment metrics, such as the return on investment (ROI) and the internal rate of return (RR).
Even with all of these calculations, the actual return you receive on a property investment will be subject to other external influences, including its type, location, individual characteristics, and market fluctuations.
The easiest way to calculate your cap rate
While there are many formulas for calculating the cap rate, the easiest is:
Cap rate = NOI / current fair market value.
So, you’re going to need to determine the NOI. This is done by subtracting the property expenses from its income stream. Expenses include but aren’t limited to:
- Insurances
- Ongoing repairs
- Legal costs
- Taxes
- Potential vacancies (a good rule of thumb is that a property might be vacant 10% of the time)
So if, for example, you rent a property for $5,000 a month and have expenses of $1,000 per month, your NOI is $4,000. Multiply this by 12 to get an annual figure, which is $48,000.
Now we can use our formula to determine the cap rate. Let’s say our property is worth $450,000. We divide this by the NOI of $4,000 to come up with a figure of 9.375. Multiply this by 100 to get your cap rate as a percentage—in this case, it’s 9.375%.
This figure means that we expect the potential return will be 9.375%. However, it’s important to know that this is before you pay any related income tax or outstanding loans secured on the property.
Now You Understand How to Calculate Your Cap Rate, Contact BRRRR Loans to Secure Financing
Property investment isn’t just the realm of big business or the wealthy. With the correct financing, it’s open to everyone. At BRRRR Loans, we specialize in lending money for a huge variety of property needs. Whether you’re looking to fix & flip, purchase a dilapidated property to do up and sell or rent, or any other reason, we’re sure to have the right financial solution for you.
Head to https://www.brrrr.com for more info and get in touch today for a confidential discussion.
Buy, Rehab, Rent, Refinance, & Repeat. A nationwide direct lender to real estate investors. If you have a project that needs to be funded, you’ve come to the right place.