What is a good cap rate for investing in real estate?
If you’re interested in becoming a real estate investor, then you’ve probably come across the term cap rate or capitalization rate, and you might have learned that the cap rate is a metric that is used to calculate the rate of return of an investment property by dividing the property’s cash flow by its market value and multiplying it by 100 in order to get a percentage-based value.
Related: What is the Difference Between Cap Rate and Cash on Cash Return?
However, you might’ve also tried to do some research on what is a good cap rate, and possibly came out missing an answer.
In order to answer the question “what is a good cap rate?”, real estate investors take a number of aspects into consideration:
- The location of the property
- The type of the property
- The timing of the investment
Since determining what is a good cap rate relies heavily on these three aspects, it actually isn’t possible to give a unified answer to the question “what is a good cap rate?”
It is, however, possible to understand how these factors can affect what is a good cap rate and what isn’t in order to help you, the beginner real estate investor, determine what is a good cap rate for your particular investment.
What is a Good Cap Rate: Location
The location of the property plays a huge role in determining what is a good cap rate based on the average cap rates in that market.
For example, if you’re investing in a market where the average cap rate is 3%, and you discover an investment property with a cap rate of 5%, it should be obvious that this property is a money maker in that market, and it will generate above-average returns compared to other investment properties in the same market.
Related: Best Places to Invest in Real Estate Based on Cap Rate
What is a Good Cap Rate: Property Type
Another factor that you should take into consideration is the type of property that you’re investing in. While each market has its own average cap rates, within the same market, certain property types will have different average cap rates than others.
In order to achieve the highest cap rates, you should search for the property type that has the highest average cap rate and then try to find properties of that type that have a higher cap rate than that average, if that makes any sense.
What is a Good Cap Rate: Timing
To put it simply, the real estate market is always shifting between being a seller’s market and a buyer’s market. Ideally, when you’re looking for investment properties with high cap rates to purchase, you will want to look for properties in a buyer’s market where you can negotiate the prices in your favor.
This, however, means that in a buyer’s market, the cap rates will be higher because the selling prices will be lower. For this reason, a good average cap rate will be higher in those markets than in a seller’s market.
Many agree that a good cap rate must be somewhere between 8-12%. However, this number is slightly unrealistic, and it is extremely difficult to find properties with cap rates that are this high (unless you’re using this tool).
Generally speaking, though, it is possible to say that a cap rate of 5% or above is considered a good cap rate in all markets, even if it is below average.
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.
Make sure to use Mashvisor during your search to find investment properties based on their cap rates.