CAP Rate: What Is It? How To Calculate CAP Rate, and more…
I am often asked by my new clients that are just starting out in real estate about CAP rates…they see them all the time on MLS in realtor listing….But are not sure what they are, how to calculate them, and why they are important. So I decided to make this video and blog post for you.
Take a quick minute to watch the video now. You will be glad you did.
So….what is a CAP Rate?
The capitalization rate (Commonly referred to as CAP Rate) is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on the investment.
So How do you calculate the CAP Rate?
Capitalization Rate = Net Operating Income / Current Market Value. Or to break it down in even easier terms you simply take the annual income – the annual expenses (Not including the mortgage payments) / the purchase price.
If you had $50,000 per year of income. $25,000 per year of expenses and you were buying a property for $350,000 your CAP rate would be 7.1%
The higher the CAP rate the better the deal. This is a quick formula you can use to determine if deal is worth pursuing further….but it is not the most important factor in any deal.
Remember, this formula does not include the mortgage payments so it’s as if you bought the property all CASH with no mortgage.
This is a formula that is used a lot by realtors… But remember as a wise investor the most important variable in your deal is the CASH FLOW.
Over the past 16 years I have analyzed a ton of deals and I have never come across a deal where all the numbers provided by the seller were 100% accurate…..
So to summarize. The CAP rate is a good tool or formula to quickly see if the deal deserves a deeper look and more of your time…..but at the end of the day you will need to do a lot more investigative work to determine if the deal will deliver the cash flow you need to create the financial independence you desire.
I hope you found this helpful. If so please share it with a friend. SUBSCRIBE to my YouTube channel for more free educational videos.
Until next time remember financial independence is not a matter of chance it is a matter of choice.