Before jumping into financing rental properties, the real estate investor should perform real estate market analysis and investment property analysis. Real estate market analysis and investment property analysis are needed to ensure that the chosen investment property will be profitable. Hence, it will help the house investor in making money in real estate.
Real estate market analysis, along with investment property analysis, consists of various components- both quantitative and qualitative. However, some of the most important information about a future investment property is retrieved from the, so called, real estate metrics. Such real estate metrics are, for instance: cash on cash return, return on investment and capitalization rate. You have most likely heard about all of them.
Today, nevertheless, we will set aside the return on investment and cash on cash return and will focus on the cap rate. What is cap rate? How to calculate cap rate? Most importantly, what is a good cap rate for rental property? Are you eager to learn what is a good cap rate for rental property? Keep on reading to find out!
#1 What is a Good Cap Rate for Rental Property: What is Cap Rate?
As you already know, cap rate is short for capitalization rate. Let’s answer the question: “What is a cap rate?” Basically, this is one of the real estate metrics used to estimate the return on investment of an investment property, regardless of the method of financing rental properties.
In order to estimate the capitalization rate, a real estate investor should know that it is based on the value of the investment property, rental expenses as well as rental income. Moreover, cap rate reveals to the real estate investor how much of the investment property’s value he/she receives in profit. Like other real estate metrics that are estimating return on investment, a capitalization rate is presented as a percentage.
When a real estate investor desires to start making money in real estate, he/she should clearly understand not only what is a cap rate, but also what is a good cap rate for rental property. However, first things first. If you want to be seen as a successful real estate investor, knowing how to calculate cap rate is one of the first steps. Curious to know when cap rate is better than cash on cash return? Make sure to read “Is Capitalization Rate or Cash on Cash Return the Better Real Estate Metric?”
#2 What is a Good Cap Rate for Rental Property: How to Calculate Cap Rate
Since you know what is a cap rate, it is just the right time to learn how to calculate cap rate. The formula itself is pretty easy to remember. Basically, you divide the net operating income (NOI) by the current market value of the property. In order to make this as clear as possible, we will examine these two variables. Curious to learn how to calculate cap rate? Make sure to read “How to Calculate Cap Rate: A Step Towards Becoming a Successful Real Estate Investor.”
Net Operating Income
To find out what your net operating income is, first of all, you should start by calculating the annual rental income. Second of all, you should compute all the expenses linked to the investment property, such as taxes, maintenance, management costs, etc. Finally, you subtract all the costs of the rental property from the annual rental income. As you can see, this formula is not that hard.
Current Market Value
Basically, this is the amount of money your rental property is worth on the real estate market. If you have recently purchased the property, you can compute the cap rate using the value of your purchase. If that is not the case, you can use real estate market analysis and compare your property to real estate comps in order to estimate the property price.
Let’s explore a possible situation. Imagine that the rental property’s value is $200,000 and you are able to rent it out for $2,000 per month or for $24,000 per year. The total amount of annual expenses reaches $4,000. Consequently, the calculation of capitalization rate is the following:
Cap rate = NOI / Property Value
Cap rate = $20,000 / $200,000
Cap rate = 10%
#3 What is a Good Cap Rate for Rental Property: The Answer
There are many answers to the question: “What is a good cap rate for rental property?” However, is there only one number every real estate investor should follow? Well, the majority of successful real estate investors agree that the good cap rate should be approximately 10%. Yet, in other markets, 8%-12% is an indication of a good cap rate. Still, a good value of cap rate may differ due to factors such as the property type and the real estate market. Let’s explore these aspects.
Multifamily properties are the ones that are generating the lowest cap rate as they are the properties with the lowest risk. It is simple. Many tenants are living in the apartment buildings. Consequently, such rental properties generate numerous rental incomes on a monthly basis. Therefore, it will not be a huge problem if one of your tenants delays with the rent payment. Moreover, your cash flow will have minor alterations. However, if we talk about single family homes, such situations may leave you without any income at all. Therefore, the risk is greater.
Real Estate Market
A cap rate which is considered to be good in one location will not be same in another. This is another thing you should understand. Every state, city or neighborhood is associated with different values indicating good cap rate. Why you may ask? The operating costs, the rents, etc. alter from one location to another. Moreover, change in the cap rate may develop over time. In one location over time, the demand or supply may increase which will cause a major difference in understanding what a good cap rate is.
#4 What is a Good Cap Rate for Rental Property: The Benefit of the Cap Rate Calculator
Well, you know what a cap rate is. Moreover, you know the formula of computing the value. Then why do you need a cap rate calculator? Let’s imagine you are in this business to start making money in real estate. How do you do it? It is obvious- you need to choose only the best investment properties! You will have hundreds of properties to choose from. If you do the computation manually, you have a chance of missing great investments. This is due to the time it will take you to complete all the calculations as well as the mistakes you might make on the way.
So, the only way to survive in this competitive environment is to use the cap rate calculator. Actually, a cap rate calculator is a type of investment property calculator. An investment property calculator computes various real estate metrics within seconds. The cap rate calculator provides the same results as an investment property calculator. The difference comes from the fact that the cap rate calculator is designed specifically for computing this numerical value. Consequently, a capitalization rate calculator saves you a lot of time as well as effort. Would like to learn more about this real estate investment tool? Make sure to read “The Hottest Real Estate Investing Tool: The Cap Rate Calculator.”