Investment Strategies How to Calculate Cap Rate for Rental Properties Most Efficiently by Victoria Daibes May 13, 2018May 2, 2018 by Victoria Daibes May 13, 2018May 2, 2018 In real estate investing, successful real estate portfolios entail much due diligence and intensive comparative market analysis. This includes studying the market, analyzing real estate investments in prime locations and neighborhoods, and capitalizing on positive cash flow properties reaping the highest ROI long term. Without measuring key real estate metrics, investors cannot guarantee a profitable and sustainable real estate business. The capitalization rate, aka cap rate is one key measure to consider in your calculations and analysis. It is an essential metric to assess the profitability of your prospective real estate investments. Related: The 4 Roads of Becoming a Real Estate Investor What is The Cap Rate for Rental Properties? The cap rate-short for capitalization rate is one key metric used in real estate investing to measure the overall profitability of a traditional or Airbnb rental property. The cap rate is one of those valuation metrics used in real estate to calculate the return on investment (ROI). It calculates the annual gross profit rate based on the property’s expected income. How to Calculate Cap Rate for Rental Properties in 6 Steps How to calculate cap rate #1: Calculate the yearly gross income of your rental property Let’s say that you have just invested in a single family home and intend to rent to tenants at a rate of $800/month. At this rate, you can expect to make 800 × 12 = $9,600 per year in gross income from your rental property. How to calculate cap rate #2: Subtract operating expenses from the yearly gross income Every real estate property comes with its own operating costs. Make sure to discount your total expenses from your gross income to arrive at your net profit. Your operating expenses may include, maintenance, insurance, taxes, utilities, vacancy costs, and property management. For example, you can expect to pay $900 in property management, $450 in maintenance, $710 in taxes, and $650 in insurance per year for your rental property. 9,600 – 900 – 450 – 710 – 650 = $6,890, your property’s net income. How to calculate cap rate #3: Divide the net income by the rental property purchase price The cap rate is the ratio between the net income of the property and its original price or capital cost. Cap rate is always expressed as a percentage. Let’s assume you purchased a rental property for $40,000. Given this information, we now have everything we need to know to find our cap rate. See below: $9600 (gross income) -$900 (property management) -$450 (maintenance) -$710 (taxes) -$650 (insurance) =$6890 (net income) / $40000 (purchase price) = 0.172 = 17.2% cap rate How to calculate cap rate #4: Use cap rate to compare similar rental properties The cap rate is used with real estate comps, which means it is a relative number. It makes no sense as a stand-alone number. Cap rates allow rough comparisons of the earning potential of investment properties and can help you narrow down your list of choices. For example, let’s say that you are debating between two rental properties in the same neighborhood. One has a cap rate of 8%, while the other has a cap rate of 13%. This initial comparison favors the second property. It has a higher cap rate, so it is expected to generate more money for each dollar you spend on it. How to calculate cap rate #5: Don’t use cap rate as the sole metric to measure a real estate investment’s profitability Do not rely solely on the cap rate to make your final decision. There are many key factors that determine the overall profitability of a real estate investment i.e. cash on cash return. To make life easier, Mashvisor’s Analytical Tool aggregates all the key metrics to give an overall ROI to safeguard profitable real estate investments, taking into account location, neighborhood and macro conditions. Related: How Predictive Analytics Gives You an Edge in Real Estate Investing How to calculate cap rate #6: Use the cap rate to justify the rental income of the investment property If you know how to calculate cap rate of rental properties, you can go backward and estimate your net income using this cap rate. For example, if you purchased a rental property for $400,000 in an area where most similar properties have about an 8% cap rate, you can multiply 400,000 × .08 = $32,000. This represents the amount of net income the property would need to generate per year to get an 8% cap rate. However, it is not advised to set rental rates based on the cap rate; they must be based on market rates and how this rental would compare to other rentals in the area. How To Calculate Cap Rate Using Mashvisor Mashvisor helps real estate investors find the best profitable real estate investments in a more (time) efficient manner. Not only does Mashvisor save you time, it also gives real estate investors immediate feedback on what kind of returns a rental property will provide and what they need to become profitable. With this said, real estate investors also have access to over 450,000 listings across the US housing market to capitalize on the best cash flow investments for traditional and Airbnb rentals. Mashvisor’s rental property calculator measures the overall ROI and profitability via the cap rate, the cash on cash return, Airbnb occupancy rate, rental income etc. You find and compare the cap rate to determine which investment opportunities reap the highest returns. How to calculate cap rate is much easier using Mashvisor’s comprehensive property details, instantly available data and centralized investment analysis. Related: How to Find Investment Properties Using a Property Finder Tool Conclusion To sum it up for you, make sure to use KPIs to assess the profitability of your real estate investments. Never invest without putting in the hours of research and intensive comparative market analysis to deduce the good real estate investments from the not-so-good properties. And there is no need to fret because Mashvisor eliminates the headache of manual work and tedious spreadsheets and streamlines the process for you to get the most out of your real estate investments in less time. To start your 14-day free trial with Mashvisor and subscribe to our services with a 20% discount after, click here. Start Your Investment Property Search! START FREE TRIAL Start Your Investment Property Search! START FREE TRIAL 0 FacebookTwitterGoogle +PinterestLinkedin Victoria Daibes Victoria is an experienced content writer who enjoys writing about all aspects of the real estate market and industry. Previous Post Buying Multifamily Property in the California Real Estate Market 2018 Next Post Are Corporate Rentals a Good Real Estate Investment Strategy? Related Posts Everything to Know About Investment Property Exit Strategies Real estate investments: How to invest money wisely The Best Real Estate Investment Strategies for Making Money in 2020 BRRRR Strategy: The Ultimate Guide for Real Estate Investors What Is a Sandwich Lease? 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