What Is Cap Rate?
Cap rate is one of the main components of conducting investment property analysis. The cap rate, or capitalization rate, represents an estimation of the real estate investor’s potential return on all cash properties. In other words, the cap rate estimates the rate of return on a real estate property. Typically, there are no specific values for a “good cap rate”. Real estate investors aim for a cap rate a little bit above the average one in their area. Usually, the higher the cap rate, the higher the potential profitability, but also the higher the risk of investing in the real estate property. Here is the formula for computing this real estate investing tool:
Cap Rate= Net Operating Income/Market Value of the Investment Property
Calculating cap rate when conducting investment property analysis can only benefit real estate investors. This is due to the fact that the cap rate offers quick analysis of the investment property. Additionally, it helps in finding the best real estate investments. Last but not least, it helps real estate investors in monitoring the performance of the real estate properties they already own. Simply put, cap rate is great tool to use if you want to make money from real estate investing.
Steps for Calculating Cap Rate
There are four steps for calculating cap rate on your own. These are namely:
#1 Calculate the Annual Gross Income of the Real Estate Property
Calculating the gross income of a real estate property is the first step of your real estate market analysis. To do so means to sum the rental income you have received from your investment property throughout the year. For instance, if you have a rental property and you charge the tenants $500 monthly, this means that your annual gross rental income is 12 x $500= $6,000.
#2 Compute the Net Operating Income
Knowing the net operating income is another essential step in predictive analytics. By subtracting the expenses associated with the real estate property from the gross rental income, you will get your annual net rental income. For instance, if you have a total sum of expenses of $1,000 yearly, your net income would be $6,000 – $1,000 = $5,000.
It is important to note that the cap rate does not calculate the business expenses such as purchase costs, fees, mortgage payments, etc.
#3 Check the Market Value of Your Investment Property
The next step in your predictive analytics is knowing the market value of your investment property. For recently sold real estate properties, this would be their purchase price. For properties that are currently on the market, that would be their asking price. Let’s imagine in our case that the real estate investment property has a market value of $ 100,000.
#4 Calculate the Cap Rate
The last step is actually calculating this real estate market analysis tool. This is simply done by filling the values in the equation. In our imaginary situation the cap rate would be:
Cap Rate = $5,000/$100,000
Cap Rate = 5%
Even though the formula is easy to use and quick to calculate, there are still many things real estate investors should watch out for. Moreover, when trying to find the best real estate investment, it is necessary to compute the cap rate for many properties. If you want to avoid all this trouble and calculations, use one of the hot real estate investing tools – the cap rate calculator.
The Cap Rate Calculator
The cap rate calculator is a specific type of an investment property calculator. No wonder it is one of the hot real estate investing tools, even the hottest one. The cap rate calculator is useful for conducting predictive analytics and helping you make money from real estate investments. The great thing about the tool is the fact that it is stress-free to use and easily accessible for free online. The cap rate calculator is a great helper in avoiding the hassle and difficulty of computing various values by hand and using the old spreadsheets. Instead of describing the cap rate calculator, let’s review some of its benefits and uses.
The Benefits of the Cap Rate Calculator
The cap rate calculator has many benefits which makes many real estate investors use the tool. Besides it accessibility and user-friendly approach, the tool can help your real estate investing business in various ways. Here are some of the most important ones:
#1 Quickly Compare Real Estate Properties
One of the benefits of using this type of investment property calculator is comparing real estate comps. Real estate comps are recently sold properties with similar characteristics to the one you are interested in. By comparing various real estate comps, you can easily estimate the real value of the property of your interest. The latter will help you in sealing the best real estate deals. Additionally, you will be able to compare the performance of various investment properties, which are still available on the market. In this way you will be able to select the best real estate investments for your business, which will bring you higher profitability.
#2 Calculate More Than Just the Cap Rate
By entering different values in the cap rate calculator, real estate investors can compute various things. Many cap rate calculators will calculate the net income for you, so you can minimize the time and effort you invest in computations. For instance, it is easy to calculate the market value of your investment property. It is necessary to enter the average cap rate of properties in this area as well as the net operating income. This computation might be extremely useful for setting up an asking price when listing you real estate investment.
#3 Determine How Much to Charge for Rent
Last but not least, the cap rate calculator can help you in determining the monthly rent of your real estate property. This can be easily done by entering the cap rate you wish your property to have. It is advisable that you do not enter a significantly higher value than the average one for your area. After you have entered the cap rate and the net annual income, you can simply add the expenses and compute the gross annual income. It is pretty easy to divide it by 12 and see what your potential monthly rent should be. Another way for choosing your rent is to calculate it as 0.8% to 1.1% of the market value of your residential property.
Even though the cap rate calculator is a great tool for your real estate investing business, the best strategy is to use more tools and conduct more analysis. Check out Mashvisor’s investment property calculator for other useful computations and beneficial information for your real estate investments.