What is a CAP Rate and How do you Calculate it?

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Before you get into the game of being a property investor, having enough knowledge and a sharp eye in choosing the right property investment will help you be successful.  The key factor in buying the right investment property is to learn how to determine the value of an income-generating property. Not knowing how to choose…

Cap Rate (1)

Before you get into the game of being a property investor, having enough knowledge and a sharp eye in choosing the right property investment will help you be successful. 

The key factor in buying the right investment property is to learn how to determine the value of an income-generating property. Not knowing how to choose the right property is a sure way of not being profitable.

One way to determine your potential return is by calculating the Cap(Capitalization) rate.

Capitalization Rate or cap rate is the gold standard for real estate investing metrics. CAP rate is the yearly return of investment that you expect to receive in rent for a property. This is an important factor as you don’t want to put your money on a losing investment.

Cap Rate is a more in-depth way to know the value of a property since it also includes the expenses.

How to calculate Cap Rate:

Cap rate = Net operating income/sales price

 First, you need to find out the Net Operating Income or NOI:

NOI = Net Income – Expenses

Other income includes parking, laundry, vending, etc.

Operating expenses include insurance, taxes, utility bills like water and electricity, property maintenance, management fees, etc.

Take a look at the graph for an example:

    Income $90,000
        Gross Rents Possible $90,000
        Other Income   $6,000
    Potential Gross Income   $96,000
        Less Vacancy Amount       $0
    Effective Gross Income   $96,000
        Less Operating Expenses     $15,000
    Net Operating Income     $81,000

Now you know what is your NOI, you are ready to calculate your Cap rate. 

Net operating income / sales price = Capitalization(cap) rate

$81,000 / $725,000 = 11.17%

So, the Cap rate of the property is at 11.17%

The next step you can do to determine if the property you are eyeing is worth your investment is to know its Estimated Market Value.

You can do this by comparing the average cap rate of the properties in the area.

Use the equation below:

 

Estimated market value = Net operating income / Cap Rate

So if another building in the area has a net operating income of $163,339 and the average cap rate in the area is say 10.33%,

Then if you use the equation,

$163,339 / 10.33% = $1,581,210 could be an Estimated Market Value of a property

If you like the numbers you get and you think it will suffice your investing goals, then you are on the right track of purchasing your investment property.

Conclusion

The cap rate simply gives you a glimpse of the current market value of the property based on its potential income. 

If you are a property investor and want to divulge in the rental property business, it is very important to know if a property can be profitable and can satisfy your financial and investing goals. 

Getting into the rental property business is a huge commitment and responsibility, so you have to know if it is worth the price.

At Green Ocean Property Management, we provide all the information needed by our clients to help them decide if a potential fits their investment requirements. Before any purchase, we can help you determine the Cap rate and the Estimated Market Value of the property so you know what you can expect should you purchase it.

We also offer you information on rental demand, tenant attraction rating to properties and most importantly, how to maximize your returns. 

We are one of the leading property management companies in Greater Boston and do more than just manage your property.

Property Management is our expertise and we can assure you that we will provide you a professional and expert opinion on which property is the best for a smart investment.

Do you need help from an expert regarding your property or you want to purchase one to use as an investment? 

Feel free to reach at hello@greenoceanpropertymanagement.com or call 617-487-4868. You may visit our office at 268 Centre St Newton MA 02458.

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