Investment Blog

What is Cap Rate?

By: Kevin Schill

When you're looking into purchasing income property, whether commercial or residential you will hear terms like GRM, NOI, Cash on Cash return, Cash Flow and Cap Rate.  If you are new to real estate investing, you may not be familiar with these terms.

Cap Rate stands for "Capitalization Rate".  It is one of the indicators we use to determine the value of a real estate investment.  Cap Rate measures the potential first year return on your investment, and ignores any debt on the property.  This gives you a clearer picture in which to do property comparisons.

Cap Rate in calculated by subtracting all of the properties expenses, excluding the mortgage, which is then divided by the purchase price.  This process can also be helpful in determining the market value of a property you currently own.

Example:

Lets say you have an apartment building with 4 units, the annual income is $100,000 and the annual expenses (including but not limited to owner paid utilities, management fees, repairs & maintenance, taxes, insurance) of $25,000, leaving a Net Operating Income (NOI) of $75,000.  And lets say the asking price for this property is $1,000,000.

$75,000 / $1,000,000 = .075 or 7.5% Cap Rate (Your potential first year return)

Using the Cap Rate is a good way to determine value of a given property by comparing it to the Cape Rates of similar properties that have recently sold in the area.  Keep in mind the higher the cap rate the better.


© Kevin Schill 2018