If you want to succeed in real estate investing, pay attention to high cap rate properties for sale. But what exactly are high cap rate investments?
Well, this article is what you need in order to learn all about high cap rate properties. To make it easier for you as a beginner real estate investor, I will address the following questions:
1. What is the cap rate and how do you calculate it?
2. What is a good cap rate? What is a high cap rate?
3. How do you find high cap rate properties for sale?
4. What tools can you use to assist you with the process of finding profitable investments?
I have put together a step-by-step guide that will cover all of the previous questions. So, without further introduction, let’s dig deep into it!
Step 1: Find Out What Is Cap Rate and How to Calculate It
The easiest way to describe the capitalization rate (cap rate) is that it’s a profitability metric which falls under the category of return on investment metrics. Therefore, in essence, it is a way of property valuation which indicates the rate of financial returns an investment property is expected to produce.
So, in order for you to better understand the capitalization rate, let’s first talk about the cap rate formula and then put it into action so you can see how it works.
The Cap Rate Formula:
The cap rate formula is as easy as 1+1=2 and it looks like this:
Capitalization Rate = Net Operating Income / Property Price * 100%
As you can see, the capitalization rate consists of two main components: the NOI and the property price.
The property price is obvious: How much did you or will you pay for the investment property (regardless of the way you financed it)? The net operating income, on the other hand, is the tricky part. In short, the NOI is the annual cash flow the rental property produces. So, let’s say that the monthly rental income is $2,000. If you deduct all the monthly expenses such as insurance and property management fees, you are left with $1,000. That is the cash flow. The net operating income is that cash flow ($1000) multiplied by 12 months which equals $12,000.
The Cap Rate Formula in Action:
Now, let’s demonstrate with some numbers.
Suppose you are analyzing some investment properties to find high cap rate properties for sale. You find one that is selling for $200,000. After analyzing some similar properties in that area (real estate comps), you find out that such income properties produce $1,500/m in rental income. The monthly rental expenses include mortgage ($500), insurance ($200), professional property management fees ($150) and ($100) for unexpected minor expenses. How do you calculate the cap rate for this investment property?
For this example, calculating cap rate requires calculating the NOI:
NOI = (Rental Income – Rental Expenses) * 12
= ($1,500 – $950) * 12 = $6,600 (This means it is a positive cash flow property)
Now back to the cap rate formula:
Cap Rate = NOI / Property Price * 100%
= $6,600 / $200,000 * 100% = 3.3%
The capitalization rate is 3.3%. The question is, is that a good cap rate? Is it considered a high cap rate?
If calculating the cap rate sounds like too much work, see Where Can You Find the Best Cap Rate Calculator for Your Real Estate Investments?
What Is a Good Cap Rate vs. What Is a High Cap Rate?
Of course, there is a difference between good cap rate properties and high cap rate properties for sale. Good cap rate properties are usually within the range of 5% and 10%, that is, if we are talking nation-wide in a very general context. Therefore, anything above that rate is considered a high cap rate.
However, don’t be quick to judge. For the previous example, this specific cap rate doesn’t mean that the real estate property is not worth the investment. After all, you can only decide if you combine it with other profitability measures such as the cash on cash return. You will also have to analyze the investment location. As we said before, the percentage is applied as a general rule. So, this specific cap rate could be considered a good one if other profitability measures indicate so.
Step 2: Identify Real Estate Markets with High Cap Rate Investment Properties
One major benefit of analyzing the cap rate is that it tells you where to invest in real estate. Therefore, the second step to finding high cap rate properties for sale is to identify real estate markets with good average capitalization rates. How do you do that? With the help of our real estate blog of course!
You need to look into certain locations and see where the market is heading and our real estate blog provides the information you need. With the help of our investment property calculator, which provides crucial data about certain real estate markets, we have put together a number of articles where you can find markets with high cap rate properties for sale. So, what are you waiting for? Go ahead and visit our blog or check out these two articles to get started.
Invest in Real Estate in the 10 Highest Cap Rate Cities in 2019
2019 Cap Rates by City: What Real Estate Investors Should Expect
Step 3: Narrow Down Your Location Options
After the real estate market analysis, you want to analyze specific neighborhoods. For this analysis, you will need Mashvisor’s heatmap analysis tool. What this tool does is it pinpoints neighborhoods with high cap rate properties for sale. In addition to this, It will show you the most important ROI metrics which determine the level of profitability you can expect in these neighborhoods like the rental income or the Airbnb occupancy rate for short-term rentals. As a result, you will be able to narrow down your choices to the best neighborhoods within a specific real estate market.
Step 4: Pick a Property Type
So, now that you have found a few neighborhoods with high cap rate properties for sale, it is time to narrow it down to the type of property you want to invest in. Since we are talking about high cap properties, you might want to focus on multi family real estate rather than single family properties. The first usually has higher capitalization rates and holds fewer risks for real estate investors than the latter choice.
Step 5: Use a Property Finder Tool to Spot High Cap Rate Properties for Sale
Of course, there is no better way to find high cap rate properties for sale than using the right tools. For this mission, the property finder tool is your best friend. With a simple step which only requires you to insert your criteria in the filter sections, you will get access to various investment properties for sale in the location of your choice. Mashvisor’s property finder tool actually allows a real estate investor to search for properties in multiple locations at once. You can set your budget, the type of investment property, the number of bedrooms and bathrooms, as well as your preferred rental strategy, and it will list all the best properties for sale with high cap rates that match it. You also get all the necessary data such as the listing price and the cash on cash return rate for both Airbnb and traditional rentals.
Final Thoughts
Congratulations, now you have found the best investment property from the myriad of high cap rate properties for sale in the market. All you have to do is take further steps to analyze it, acquire ownership, and put the rental property to work to start generating rental income!