When a person enters the real estate industry, he/she is usually ready to select the best places to invest in real estate and the best investment property. However, it is not as easy as it may look. There are many aspects you should keep in mind when planning on investing in a property, such as investment property mortgage rates, methods of financing, real estate data, return on investment metrics, etc.
However, today we focus on one of the most important and commonly used real estate metrics: the cap rate. We will also talk about what is a good cap rate. Moreover, we will explain how to calculate cap rate and what tools you should be using in 2019 in order to boost your level of efficiency. Ready? Keep on reading!
#1 What Is a Cap Rate for Rental Property?
Maybe you’ve heard of the capitalization rate? Well, it’s the same thing as the cap rate. So, what is cap rate? It is one of the real estate metrics typically used in order to estimate the return on investment of an income property, regardless of the method of financing.
To calculate the cap rate, a real estate investor should understand that it is built on the value of the investment property, the rental income, and the rental expenses. Additionally, the cap rate reveals to the investor how much of the income property’s value he/she receives in profit. Cap rate is presented as a percentage like other real estate metrics that are used to estimate a good return on investment.
#2 How to Calculate Cap Rate
Well, now that you know the definition of cap rate, it is the perfect time to learn how to calculate cap rate. The formula, in general, is easy to remember:
Cap Rate= NOI/Property Value
To calculate cap rate, divide the net operating income (NOI) by the current market value of the income property. However, to make it as clear as possible we will examine these two variables.
Related: How to Calculate Cap Rate Most Effectively: A Simple Guide
Net Operating Income
The first step in calculating NOI is computing the annual rental income. In the second phase, the investor should calculate all the expenses that are linked to the investment property. As a final step, you should subtract all the costs of the income property from the annual rental income:
NOI= Annual Rental Income- Annual Rental Expenses
As you can see, it is not hard to calculate the net operating income. But it might be very time-consuming. Consequently, we suggest using Mashvisor’s cap rate calculator. This tool will help you save time and effort and will eliminate the risk of making a mistake in any step of the calculation.
Current Market Value
The current market value is the amount of money your income property is worth on the real estate market. In order to find out what the current market value of your investment property is, you should conduct comparative market analysis. This involves exploring the local housing market and estimating the value of your property on the basis of real estate comps.
Again, we highly suggest using Mashvisor’s real estate investing tools. Within a few seconds, you get precise results. That’s because every rental property on the platform is accompanied by a ready list of real estate comps. You’ll be able to track real estate market trends and know the value of the property easily.
Related: How to Do Comparative Market Analysis Step by Step
#3 What Is a Good Cap Rate?
“What is a good cap rate?” is a commonly asked question among many real estate investors. However, when we talk numbers, is there a standard percentage that everyone should try to reach in 2019?
Well, the majority of successful real estate investors agree that a good cap rate for rental property should be about 10%. However, a good cap rate for rental property in certain markets can reach the level of 8% – 12%. Consequently, what is a good cap rate at location A might be different from location B. This is because different factors can influence the rate of so-called good cap rates. For instance, the property type, as well as the real estate market itself, affect this value. Let’s examine each one further.
Related: What Is a Good Cap Rate for Investing in Vacation Home Rentals?
Real Estate Market
A good cap rate in one location in the US housing market 2019 might not be the same in another. Every real estate investor should understand that every city, neighborhood, etc. is different when it comes to investment potential. Thus, every neighborhood will have its own values that will indicate a good cap rate for rental property.
How you may ask? Well, the median property price, operating costs, and rental income vary from one location to another. In addition to this, what is a good cap rate is affected by the demand and supply in the real estate market which can differ greatly from one location to another, even in the same city.
Investment Property Types
When we talk about multi-family income properties, we are talking about rental properties that typically are of low risk. Thus, such income properties generate the lowest cap rate.
Why? It is simple to explain. Multi-family properties generate numerous rental incomes on a monthly basis. Thus, if one tenant is late with the monthly payment, it will not be a huge bottleneck. Your cash flow will be less, sure. However, if we talk about single-family homes, you should be aware that when a tenant is late on the payment, you might be left without any rental income at all. Therefore, the risk is much greater. So, in theory, the higher the risk, the higher the cap rate of the investment property. Variations of this rule apply, of course.
It is also extremely important to note that a good cap rate of 8%-12% is the standard book value. Such cap rate values are hard to reach in actual real estate markets due to the constant evolution of the market. The changes in the supply and demand relations and the constant variations in prices and market values make it more difficult to get such a high cap rate on property.
You can, however, find high cap rate properties for sale with this tool.
Therefore, many real estate investors consider a cap rate of 4%-5% a good value and a property worth the investment. Remember to take into consideration all external factors when determining whether a certain result classifies as a good cap rate value.
The Bottom Line
You now have a good understanding of what is a good cap rate for rental property and you have the formula in your pocket. Consequently, you have everything in order to make the necessary calculations. Use this carefully in order to find the best places to invest in real estate. Remember to judge a cap rate value based on the local market and the individual rental property.
Use Mashvisor’s cap rate calculator to make your job easier and get your necessary results within seconds. To start your 14-day free trial with Mashvisor and subscribe to our services with a 20% discount after, click here.