How to Calculate a Real Estate Cap Rate and Why It’s important to Know

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The real estate world can be volatile. Property values increase and decrease on a regular basis. Learning how to surf the waves of the real estate world and be successful is possible. It is an exciting, ever-changing market where you can never have too much knowledge. Capitalization Rate, or Cap Rate for short, is going to be one of the most valuable tools available to you. However, you need to know how to use it and what to use it in conjunction with for it to be the most useful to you. There are many factors and risks you take when buying properties. Cap Rate is one of the tools you can use to ensure you are taking the least risk possible. No one wants to lose money.

What is a Real Estate Cap Rate

Capitalization Rate essentially is an equation. Of course, it is not a simple equation, but in the most basic terms, presenting the Car Rate in terms of an equation is the most logical way to understand it. The answer to this equation is how much risk there is in buying a property. Cap Rate is a great way to calculate how much money there is to be made or lost when investing money in real estate . Using this tool will guide you on your journey of figuring out whether a particular property is right for you. Cap Rate is also the most accurate way to know how long it will take you to make your money back on property investment. As crucial as Cap Rate is, you must understand that Cap Rate by itself is almost useless. Using the Cap Rate together with other resources can prove to be one of the best mitigation tools available to a potential property buyer. With all the choices out there for purchase, you must be diligent and do all you can to ensure a property is right for you.

How Do I Know if the Cap Rate is Good?

In the real estate world, you are looking for a lower Cap Rate. Lower Cap Rate equals lower risk, higher Cap Rate, higher risk. A good Cap Rate is typically four to ten percent. That is the ideal amount of risk on a property before you invest in it. A Reasonable Cap Rate will be a good figure that balances net operating income compared to the initial cost of the property in question. So Good Cap Rate will be better or worse for you depending on how much you are willing to risk. If you have a hunch, or if you can grab up some property with a higher Cap Rate in a developing area, it may be worth it. When it comes to real estate properties in general, risk management is going to be your most challenging foe. So, using something like Cap Rate will help you decide how much risk you are willing to take. Before you even get to find a good or bad Cap Rate, you need to know already how much you will be willing to risk.

Why Do I Need to Know the Cap Rate?

In short, it is essential to know your Cap Rate because it is the best basic equation for knowing how long it will take you to make your money back on investment. Cap Rate is more for long-term property purchases rather than, say, a buy and flip situation. So, if you are going in for long-term property investment, you will want to know how long it will take to get your money back and move on to other opportunities.

How to Calculate the Cap Rate

The equation for Cap Rate is relatively simple . The important thing is the accuracy of your numbers.

  • You need to know is the property’s net operating income (NOI).
  • You need to know the price of the property.
  • Then, you divide NOI by property price, then multiply that by a hundred, and there you go, you have your Cap Rate.

Be advised; Entering incorrect information into this simple equation can be troublesome. The price is the price, but make sure the net operating income is one hundred percent accurate. This should be simple enough to find out, but it would not hurt to do your homework to correct the number. If that number is off, your Cap Rate is going to be inaccurate and essentially useless. To be sure you are getting an accurate Cap Rate, do the math yourself. First, add up the total income the property receives from the rent of its tenants, then subtract the total number of operating costs. That should give you the accurate figures you will need. It is unfortunate, but you need to make sure your seller is honest and upfront with their numbers when it comes to money and investments.

When to Use a Cap Rate

A simple way to know whether or not to use Cap Rate depends on precisely what you are buying. Not only what you are buying but what your intentions for the property are going to be. Using a Cap Rate is not for quick house flips or land purchases. Instead, the cap rate is a long-term equation designed to give you an idea of how long it will take you to make your investment back. House or property flipping is more of a get-in and get-out of a possible purchase as fast as possible. You are not taking the time to figure out your annual income. You are just fixing up everything you can, as cheaply as you can, and then trying to sell it off for profit. Cap Rate really will not help you in this type of situation. If your purchasing land, the Cap Rate will not be helpful because there is no accurate NOI. Cap Rate is a number you get annually; you have no idea what a piece of land with no property can yield in a year. Taking a guess based on similar properties NOI’s is also not recommended because there are far too many variables to consider.

Can Cap Rate Change?

You can quickly increase your Cap Rate while owning a property to get yourself a better profit when it comes time to sell. Doing simple renovations is a great way to be able to charge more for rent. While this will cost you upfront, it is a great way to increase your NOI. Getting a good deal on utilities and including them in the rent cost is another great way to up the value for your tenants. Usually, internet and power companies will offer significant discounts for bulk accounts. Contact local companies and find out if some of these options are available in your area. Amenities like this will allow you to charge more for rent and get a discount on the apartment’s utilities at the same time.


If Cap Rate is suitable for your property purchase, it can be a beneficial tool. However, knowing how long your investment will take to recoup is essential in the world of property buying and selling. It is an easy equation, but it is vital to know how much you are putting at risking when purchasing a rental property. Just be sure you have accurate figures when doing your math. You don’t want to end up with the wrong numbers. Be sure your aware of all expenses and subtract that from the NOI. Then, do the math yourself and add up all the rent values for the year to ensure you get an accurate and useful Cap Rate. As long as your sure of your numbers, you can feel free to buy today ! Sources: What Is A Good Cap Rate & How To Calculate It | Capitalization Rate - Overview, Example, How to Calculate Cap Rate | The 2020 Real Estate Investor’s Guide to Understanding Cap Rates... |

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