As a real estate investor, or a person interested in real estate investing, you have probably already heard of all kinds of real estate metrics needed for getting to know how to make money in real estate. One of these important metrics is calculating the cap rate on investment property. “But how to calculate cap rate?”, you may ask. Well, do not be in a hurry, we will get to the answer of this question. However, in order to become a successful real estate investor, you need to really understand cap rate. That is why we will explore this real estate metric in depth. Are you interested in learning the answers to questions like: “What is cap rate?” and “What is a good cap rate for investment property?” as well “How to calculate cap rate?” Keep on reading to find the answers.
#1 What Is Cap Rate?
What is cap rate is the first thing you need to understand when learning how to calculate cap rate on investment property. Cap rate is a metric used in real estate investing to estimate the real estate investor’s potential return on all cash properties. Cap rate on investment property is the rate of return on a property based on the income which the property is expected to generate. The formula for calculating cap rate on investment property is as follows:
Cap Rate= Net Operating Income/Current Market Value
Logically follows the question: “What is a good cap rate for investment property then?”. When learning “What is a good cap rate for investment property?”, the real estate investor should not seek precise numeric values. A good cap rate is defined as the average or a bit higher than the average one in the area of interest. Nevertheless, the higher the cap rate, the higher the potential profitability, but also the higher the risk of real estate investing. Using cap rate is a way to understand how to make money in real estate. Yet, before exploring how to calculate cap rate, we firstly need to discuss the benefits of this metric.
Related: How Do You Choose the Best Rental Properties for High Cap Rate
#2 The Use of Cap Rate: Why Is it Important?
As previously described, cap rate estimates the real estate investor’s potential return on all cash properties. Additionally, the cap rate offers quick investment property analysis when looking for the best real estate investment opportunities. Moreover, it helps you in monitoring the performance of real estate properties you already own. If the value of the cap rate increases, then the property is performing well on the real estate market. Last but not least, cap rate can be used in order to compare several properties before choosing the right one for your next investment.
Once we have discussed the basis of cap rate, it is time to move on and explore how to calculate cap rate on investment property.
#3 How Do You Figure Out Cap Rate on Investment Property?
How do you figure out the cap rate on investment property? Well, there are a couple of steps you should follow in order to learn how to calculate cap rate on investment property:
- How to Calculate Cap Rate? Calculate the Annual Gross Income of the Real Estate Property
As the formula suggests it, calculating cap rate is dividing the net operating income over the current market value of the property. In order to calculate the net operating income, you first need to compute the annual gross income of the real estate property. The annual gross income is the sum of the income you have received form the real estate investment throughout the year. Let’s say you rental income was $400 per month. This leaves you with an annual gross income of 12 x $400= $4,800.
- How to Calculate Cap Rate? Compute the Net Operating Income
The net operating income is a key part of learning how to calculate cap rate. The net operating income is easily computed by subtracting all expenses associated with the property from the annual gross income. For example, if the costs related to your rental property sum up to $800 yearly, your NOI would be $4,800 – $800 = $4,000. It is important to know that the cap rate does not compute purchase costs, mortgage payments, and fees as a part of these expenses.
- How to Calculate Cap Rate? Check the Market Value of Your Investment Property
The following step in understanding how to calculate cap rate is to establish the market value of the property of your interest. For instance, for recently sold properties, the market value is their purchase price. For properties currently on the real estate market, it is their asking price. However, you can also calculate the approximate market value of a property through conducting real estate market analysis. Anyways, let’s imagine that in our case the market value of the real estate investment property is $80,000. This is the other variable in the equation. Thus, we are only left to compute the cap rate itself.
- How to Calculate Cap Rate? Compute the Cap Rate Itself
How to calculate cap rate for investment property? Once you have completed the previous steps, it is easy: just fill in the blanks in the formula.
Cap Rate = NOI/Current Market Value
Cap Rate= $4,000/$80,000
Cap Rate = 0.05
Cap Rate = 5%
Sure enough, completing all these steps by hand takes a great amount of time. Moreover, when trying to understand how to make money in real estate, investors are comparing the cap rates of various properties in order to find the best one. That is why there is an investment calculator designed to compute cap rate easily and quickly.
Related: Learn How to Calculate Cap Rate to Buy the Best Investment Properties Always
#4 The Cap Rate Investment Calculator
The cap rate calculator is a specific type of investment calculator making the computation of the cap rate metric stress-free. The tool is easily accessible online and can be used as an Airbnb calculator. It is a great tool to use when willing to become a successful real estate investor. The cap rate calculator is great to use when comparing various investment properties, deciding how much to charge for rent, etc. It is considered to be one of the hottest real estate tools on the market, so do not miss it.
Related: Do Real Estate Investors Need a Cap Rate Investment Property Calculator?
Did you learn how to calculate cap rate? Are you interested in learning how to compute other real estate metrics and how to use them? Go visit Mashvisor for more information on numerous real estate topics!