You should already know that the path of becoming a successful real estate investor is not as easy as many beginner realtors imagine it to be. Obviously, it is all about finding the best real estate investing properties. The most important part is financing income properties which generate positive cash flow. However, this is easier said than done! In order to avoid negative cash flow properties and find positive cash flow ones instead, you should have a clear knowledge about various real estate metrics. This is also the basic step in learning how to make money in real estate. Well, one of the main metrics used in real estate investing is the capitalization rate, better known as cap rate. What is cap rate then? Why is it important to you as a real estate investor? How to calculate cap rate? How does it let you make money in the field of real estate? Keep on reading in order to find the answers!
#1 What Is Cap Rate
Of course, before all else, we need to answer the question: “What is cap rate?” Simply put, cap rate is a real estate metric used as an estimation of the real estate investor’s potential return on cash properties. The metric indicates the potential rate of return based on the income the real estate investment is expected to generate. In order to really understand what is cap rate, we will explore the topic further. When asking “What is cap rate?”, we also need to ask: “What is a good cap rate?” To be honest, there is no such a value or values which define a good cap rate. For some real estate investors, the value of the cap rate should fall between 8% to 12%, while others opt for at least 20%. Nevertheless, it is important to note that the higher the cap rate, the higher the potential profitability associated with the real estate investment. However, besides higher profitability, higher cap rate values are an indication of higher risk too.
#2 How to Calculate Cap Rate
Once you know the answer to the question “What is cap rate?”, it is time to learn how to calculate cap rate. The formula is pretty simple:
Cap Rate = Net Operating Income (NOI)/Current Market Value of the Property
There are few steps you need to complete in order to reach the answer. For instance, you first need to get the value of your net operating income. You do so by computing the annual gross income first. The simplest way to do this is by multiplying the rental income you receive monthly by twelve. Once you have that value, you subtract the costs associated with the property, and you get the NOI. The current market value of a recently sold property is its selling price. When it comes to the current market value for sale on the market, we take the asking price. However, if you want to know the current market value of another property, you need to perform real estate market analysis first.
To make it easier for understanding, let’s take a simple example for calculating cap rate. You, as a real estate investor, are looking for some income properties which have current market value of $500,000. The estimated annual income of one of these income properties is $50,000. Thus, the cap rate is:
Capitalization Rate = $50,000/$500,000
Cap Rate = 0.1
Cap Rate = 10%
As you can see, it is not that hard to calculate the cap rate once you know the values of the needed variables. However, when looking for the best real estate investing opportunity, calculating what is cap rate might get challenging. The reason behind this is the fact that you would need to learn the cap rate for various properties before finding the best one. Therefore, in order to avoid wasting your time or making a mistake while completing every step by hand, we advise you to use Mashvisor’s rental property calculator.
Related: Learn How to Calculate Cap Rate to Buy the Best Investment Properties Always
#3 The Cap Rate Calculator: A Type of Rental Property Calculator
As a real estate investor, looking for the best properties on the market using a cap rate calculator is a great option. The cap rate calculator is a type of a rental property calculator. The tool shows you the calculated cap rate of an investment property/properties quickly and accurately. In this way it saves you tons of time and effort as you do not need to make computations such as finding what is cap rate for many properties manually.
Of course, using the investment property calculator is another option for computing the cap rate fast online. There are many different rental property calculators, but Mashvisor’s rental property calculator is the best one! Besides showing you what is cap rate for a chosen property, it will provide you with in-depth analysis of any location. It will present you everything about the average pricing, cash on cash return, rental income, and other statistics. By using this information, you can easily understand if properties will generate positive cash flow or negative cash flow.
Related: How Can You Find a Rental Property Calculator for the Best Real Estate Investments?
#4 How to Make Money in Real Estate Using Cap Rate
By now, you have probably learned by heart that the cap rate indicates the real estate investor’s potential return on all cash properties. However, that cannot be the only way in which knowing what is cap rate helps you make money. Of course, it is not! Cap rate is a metric which can be used as a quick indication of whether an investment property is worth it or not. Additionally, cap rate can be used in order to monitor the performance of various real estate properties you already own and manage. It is simple. If the value of the cap rate increases, the investment property is performing well. One other benefit of using cap rate in order to make money in the field of real estate is that if gives you the ability to quickly and accurately compare different properties in order to find the best one for your real estate investment portfolio.
Related: The Hottest Real Estate Investing Tool: The Cap Rate Calculator