Please help me understand Cap rates

[Jessica Martin]

Im taking my real estate classes now and going over Cap rate right now and I really want to make sure I have a good grasp on how to figure Cap rates. I'm still a little confused about it. Do you use gross or net amounts?

Please use for example: I can purchase a house for $50k and it will rent for $1,000/month.

First of all, is cap assumed to be purchasing the property cash? Because financing would include interest which would be an additional cost of ownership taking away from net profits.

Second, do I go ahead and multiple the rent of $1,000 by 12 months and then divide by the homes value to get the cap rate? Or do I subtract taxes, insurance, exc from monthly rent before multiplying and dividing?

Third, is value determined as the amount I paid for the home, or is it determined as the assumed market value per comps... I ask this question because I do wholesale, so I get properties under market value, so i need to know if cap is figured by price paid or by the actual presumed market value per comps? Im assuming market value but I want to make sure that is correct? Would love to know how to figure cap rate for my buyers.

Would really appreciate feed back on this! Thank You!

[Wayne Brooks]

Cap rate uses the Net income (excluding any financing/loan costs) divided by the purchase price.  So, net income After all expenses (taxes, insurance, ongoing repairs, maintenance, capex, utilities, etc) and ignoring any loan payments.  The cap rate is the same whether paying cash, or financing.  It is based on the assumed purchase price/closing costs/upfront repairs for the buyer.