WHAT IS THE ===>>> Cap Rate ???

Edited by Capital Equity Partners Team, Peter, Maniac, Elizabeth Donald

Real estate investors rely upon a variety of information when negotiating or purchasing income producing properties. The investor utilizes all available information about the property from the desirability of its current location to prospective changes in the neighborhood when evaluating the investment potential of a property. One main source of information is called the capitalization rate or cap rate. A cap rate is useful in determining the maximum amount that an investor should spend given the annual return that investor plans to make. The cap rate allows investors to compare properties by evaluating a rate of return on the investment made in the property. The cap rate allows investors to compare properties even though those properties have different net income and purchase prices. Since the information is so useful in making across the board comparisons on income properties, it is very important that investors know how to figure the cap rate of property investments.

EditSteps

1
Calculate the net income of the investment property. The gross income will mainly come through the rent rolls, although miscellaneous income might also accrue from the property. This could be in the form of coin operated vending or washing machines.
2
Calculate the expenses associated with the property. The cap rate won't account for all of the property's business expenses. It includes only the operating expenses. As a result, it does not include the purchase costs of the property including mortgage payments or fees. Since those items reflect the investor's standing with the lender and are variable in nature, they would affect the neutral comparison that the cap rate is meant to deliver. When evaluating the expenses you should evaluate the numbers to reflect your planned management of the property.
3
Calculate the cap rate. The cap rate is a ratio between the net income of the property and its original price or capital cost. It is calculated as Cap Rate = the annual net operating income / cost (or value).
4
Understand how cap rate can be used by the investor. The investor can start with her desired rate of return and then use the cap rate to establish the asking price of the investment property. For instance, if the investor wants to generate a net income of $10,000 for year one, and wanted an 8% cap rate, then the asking price should not exceed $125,000.
5
Example: An investor purchases a home for $40,000. It is currently rented for $750 per month ($9000 per year). There is a 10% property management fee, $710 in taxes, $650 for insurance and figure 5% for maintenance.
- $9000 (gross income)
- -$900 (property management)
- -$450 (maintenance)
- -$710 (taxes)
- -$650 (insurance)
- =$6290 (net income) / $40000 (purchase price) = 15.7% cap rate