{"id":794,"date":"2018-06-25T10:30:20","date_gmt":"2018-06-25T15:30:20","guid":{"rendered":"http:\/\/www.realtyhop.com\/blog\/?p=794"},"modified":"2022-06-14T11:11:04","modified_gmt":"2022-06-14T15:11:04","slug":"what-is-cap-rate","status":"publish","type":"post","link":"https:\/\/www.realtyhop.com\/blog\/what-is-cap-rate\/","title":{"rendered":"Cap Rate – What Is It and Why Is It Important?"},"content":{"rendered":"
You\u2019re deciding between a few options when purchasing a piece of property to rent it out and generate rental income. In this case, you will be wise to compare the cap rates between the two properties to understand the associated risk in moving forward with either.<\/p>\n
While purchasing property, you operate under the assumption that your asset will appreciate by the time you decide to sell. However, to best understand the potential risks and benefits of several options, you will refer to various metrics like a cap rate to draw stronger conclusions. Continue reading to learn more about what a cap rate is and how to calculate and interpret that information to aid in your decision-making process.<\/p>\n
The capitalization rate, commonly referred to as the \u201ccap rate,\u201d measures the rate of return on a real estate investment property based on the income it generates. It explains how much an investor can potentially make or lose from their investment property. A formula produces the exact cap rate, but that number serves simply as a prediction of the amount of money an investor can receive; it is not a concrete number. Additionally, cap rates are subject to change based on several variables, explained further below.<\/p>\n
While cap rates are commonly used when exploring the potential for commercial real estate, RealtyHop displays the cap rate for residential properties for investors looking to generate income from a residential home. Furthermore, even buyers who plan to occupy their home as their primary residence can utilize a cap rate to determine the risk associated with their purchase.<\/p>\n
The most common way to calculate the cap rate is as follows:<\/p>\n
Cap Rate = Net Operating Income (NOI) \/ Property Asset Value<\/b><\/p>\n
In the above equation, the net operating income (NOI) refers to the expected generated annual income after deducting all expenses. If you acquire a property you intend to rent out all year; you may expect to make $75,000 from rental income. However, if you spend $1,000 a month ($12,000 a year) to keep the property in liveable condition, you will deduct $12,000 from $75,000 to arrive at an NOI of $63,000. Now, suppose your property\u2019s asset value is $100,000, your cap rate equation then looks like the following:<\/p>\n
0.63 = $63,000 \/ $100,000 <\/b><\/p>\n
To arrive at a percentage, simply multiply the 0.63 by 100 to receive a 6.3% cap rate.<\/p>\n
Cap rates can change for the same property depending on NOI and asset value shifts. The below two tables demonstrate the relationship between a shifting NOI or asset value and the cap rate of a speculative asset.<\/p>\n
The tables below further illustrate how cap rates are affected by NOI and asset value.<\/p>\n
When NOI changes:<\/p>\n