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Capitalization Rate (Cap Rate)

Just like we have a key income value (NOI) that is completely independent of the details of the financing, we also have a key ROI value that is also independent of the buyer and the details of the financing. This value is known as the “Capitalization Rate,” or “Cap Rate.” Cap Rate is calculated as follows:

Cap Rate = NOI / Property Price

If there is a single number that is most important when doing a financial analysis of a rental property, the Cap Rate may be it. Because the Cap Rate is independent of the buyer and the financing, it is the most pure indication of the return a property will generate.

Here is the cap rate for our example property:

Cap Rate = NOI / Property Price

= $37,169 / $418,000

= 8.89%

Another way to think about Cap Rate is that it is the ROI you would receive if you paid all-cash for a property. Though, unlike cash flow, where the value is maximized by paying all cash, the Cap Rate is *not* necessarily the highest return you’ll get on a property. This is because Cap Rate assumes that the investment amount is the maximum (the full price of the property), and we learned above that the value of ROI calculations goes up as the investment amount goes down.

So, what is a good Cap Rate? It really depends on the area of the country you’re in, but in general, most areas see maximum Cap Rates in the 8-12% range. And just like the value of single family houses are based on the prices of comparable houses in the area, the value of larger investment properties are usually based on the Cap Rate of comparable investment properties in the area. So, if the average Cap Rate in your area is 10%, you should be looking for at least an 10% Cap Rate for your property (barring other more complex situations and considerations).

Looking for high quality investment properties in Mercer County?  I specialize in your success in Princeton, Princeton Junction, Hamilton, Lawrence, East Windsor, West Windsor and the state capital of Trenton.  Looking to become a landlord....draw on my experience.

Robert Farmer 609-444-8204  or robert@solutionsinrealestate.net

Contact: Robert Farmer  609-444-8204 or robert@solutionsinrealestate.net

Real Estate, REO’s, Foreclosures, Short Sale, Flipping houses, Multi-Family, Hard Money, Mortgages, Investing, RE Investing, Sales, auctions, rehabs, discounted notes, For Sale By Owner, lease options, Mercer County, Hamilton, Lawrenceville, Princeton, Princeton Junction, Trenton, East Windsor, West Windsor, Mercerville, Lawrence.

Posted By - Robert Farmer - 2 days ago

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