Joe Capote – Certified Investment Agent Specialist Expert in Real Estate Investments and Properties

The Cap Rate is short for capitalization rate. Cap rate is simply the rate at which an investment property earns money, depending on the value of the property. It is calculated by taking the net operating income – gross rent minus expenses – and dividing by the value of the property.

Example:

1. A property is purchased for $100,000. This is the value of the property.
2. The property brings in $1000 per month, or $12,000 annually.
3. The property costs $400 per month to maintain, or $4800 for the year.
4. Net Operation Income (NOI) is $600 per month, or $7,200 per year.

$12,000 – $4,800 = $7200

$7,200/$100,000  = .072 (7.2%). The cap rate of the property is 7.2%.

Cap rate is an important calculation used when evaluating the financial performance of a property, and one that investors use frequently to give an “apples to apples” comparison of two properties.  For example, properties can vary greatly in price and net operating income, but have the same cap rate, making them equivalent investments.

Cap rates vary from market to market. A higher end investment (desirable area, better amenities) may have a lower cap rate than, say, a property in a less desirable area with less amenities. This is a premium the investor pays for a better quality property in a more desirable neighborhood.  

The cap rate is one of many tools used to evaluate a property’s financial potential. The investor must determine the type of investment and the overall investment package in order to make a clear decision on what is best. A good real estate investment professional can help determine this and other factors, such as tax basis, cash on cash return and the debt service ratio.

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