Is your rental property a 10? Use 'Cap-Rate'​ analysis to help maximize your profit

[Michael Farinello]

Cap rate, short for capitalization rate, is a metric used to evaluate the performance of an investment property; and is a widely accepted metric in the real estate industry used to compare the potential returns of different properties. By determining the cap rate of a property, an investor can compare it to properties in the same area and with similar characteristics to determine its relative performance. It can also be used to compare different properties, even if they are not similar in terms of size, location or type.

Why is this important?

A higher cap rate may indicate a better return on investment, while a lower cap rate may indicate a higher risk investment. It allows for the analysis of risk and return. Properties with higher cap rates may have greater potential returns, but also come with more risk. By understanding the cap rate, an investor can make more informed decisions about the level of risk they are willing to take on.

So how is cap rate determined?

It is calculated by dividing the net operating income (NOI) of a property by its purchase price or current market value, the resulting percentage is the cap rate. Here is an example:

Let's say a rental property generates $60k in annual rental income and has operating expenses of $10k per year. The NOI for this property would be $50k. If the purchase price for this property is $500k, the cap rate would be 10% (NOI of $50k divided by purchase price of $500k).

It's important to note that the cap rate is not the only metric that should be considered when evaluating an investment property. Other factors such as location, condition of the property, and potential for appreciation should also be considered.

It can only help to consult your realtor, a market expert, or a loan officer like myself to understand the values, operating income and expenses of any particular property.