The ultimate goal of investing in real estate is to make a profit. This statement holds true for all types of real estate, especially residential real estate. When measuring profitability in real estate, return on investment (ROI) is used. One of the most important forms of ROI is cap rate. So, what is cap rate? And where can you find cap rates for residential rental property?
Related: What Is the Average Real Estate Return on Investment in the US?
What Is Capitalization Rate?
Before we talk about finding cap rates for residential rental property, we need to cover the essentials of cap rate. Cap rate, short for capitalization rate, is one of the most widely used ROI metrics. As a measure of the rate of return on rental property, cap rate determines profitability regardless of investment property financing. Cap rate depends on a variety of factors, such as rental income, expenses, and property value. Cap rate also indicates how much of the property’s value is received as profit. The higher the cap rate, the more profitable the residential property.
How to Calculate Cap Rate
The Cap Rate Formula
How do you calculate cap rate? The cap rate calculation is quite simple. Based on the definition, the cap rate formula is:
Cap Rate = [Net Operating Income (NOI) ÷ Fair Market Value (FMV)] × 100%
As you can see, the cap rate formula depends on two variables. But what are they, exactly?
The first factor is net operating income. NOI is the difference between annual gross rental income and annual operating expenses:
NOI = Annual Gross Rental Income – Annual Operating Expenses
Annual gross rental income is the rental income collected in a year. Operating expenses refer to any expenses used to maintain and run a residential rental property. These include taxes, repairs, insurance, maintenance, and much more. However, mortgage payments and other financing costs are not included as operating expenses in the cap rate formula.
Related: A Comprehensive List of Rental Property Expenses for Investors
Fair market value is the second value in the cap rate formula. FMV refers to the value of a property at a given time. In other words, FMV is the same as the property price.
An Example of the Cap Rate Calculation
To hammer home the cap rate formula, let’s use a quick example. A real estate investor earns $35,000 in annual rent from a single-family rental. The SFR costs $5,000 to operate during that time. If the property’s FMV is $280,000, what is its cap rate?
Cap Rate = ($35,000 – $5,000) ÷ $280,000 = 0.107 × 100% = 10.7%
What Is a Good Cap Rate?
After seeing the previous example, you might be wondering, what is a good cap rate? Specifically, what are good cap rates for residential rental property? The answer is, it depends. The range of what is a good cap rate varies. Many factors must be considered.
For starters, the location of an investment property can significantly impact the cap rate. Metro areas, for instance, tend to have lower cap rates than rural and suburban areas. For residential real estate, property type is another huge factor. Multi-family homes, especially those with 4 units or more, are generally more profitable than single-family rentals. As a result, they tend to have higher cap rates than SFRs. Still, many experts claim that cap rates between 5% to 12% are considered good.
Above all, when analyzing good cap rates for residential rental property, you need to remember one thing. Residential real estate return on investment depends on location. What matters most is the good cap rate range that exists in your location. Keep in mind, however, that cap rates by city or by neighborhood are more informative than state-wide cap rates.
Where to Find Cap Rates for Residential Rental Property
This all brings us back to the original question. Where can you find cap rates for residential rental property? With this information, you can find out if an investment property’s cap rate is considered good within its location.
On the surface, it might seem like finding the cap rate for investment property would be hard work. With Mashvisor, however, it takes mere minutes. By using Mashvisor’s heatmap analysis tool, you can study the cap rate of any rental market in the US. Then, after you’ve found a property of interest, you can analyze its cap rate with Mashvisor’s cap rate calculator.
How to Use Mashvisor to Find Cap Rates
So, how can you use Mashvisor to find cap rates for residential rental property? We’ll briefly cover this topic here. However, you can try out Mashvisor’s tools yourself right now! CLICK HERE to start a 7-day FREE trial with Mashvisor.
Let’s start with the heatmap analysis tool. First, enter the location where you want to find residential properties. Then, the heatmap will present cap rate data along with more property data for the area.
Although the filter pictured above is named “Cash on Cash Return,” keep in mind that cap rate = cash on cash return when you’re buying rental property with cash.
Related: How to Find Cap Rate for a Real Estate Market
A list of available real estate listings will also appear. You can select any investment property and read Mashvisor’s cap rate estimations. Now, you can use Mashvisor’s interactive cap rate calculator. A user can adjust property input data, such as estimated operating expenses, to see how the cap rate will be affected. By using Mashvisor’s tools, you can find the best cap rates for single-family homes and multi-family properties.
How Mashvisor Finds Cap Rates for Residential Rental Property
You might be wondering, how does Mashvisor find cap rates for residential property? Mashvisor uses a variety of data sources to help you find the most profitable investment properties. The calculator works by using user input, collected data, and historical trends and predictive analytics. As a result, Mashvisor can help you find the best cap rates for multi-family homes, single-family homes, townhouses, condos, and many other types of residential real estate.
The Bottom Line
Cap rate is a vital ROI metric in real estate. It allows investors to understand the profitability of their investments. The cap rate formula is straightforward but also very insightful. By understanding it, investors can learn how to maximize their cap rate. The range of good cap rate varies depending on location and property type. And with Mashvisor’s tools, investors can find the best cap rates for residential rental property. To learn more about Mashvisor’s real estate investment tools, CLICK HERE!