How to Calculate Real Estate Capitalization Rates (CAP Rates)
If you are looking to purchase investment property, you are going to see the term CAP rate, or real estate capitalization rate, used quite frequently. Fortunately, CAP rate is easy to calculate and easy to understand.
The first step to calculating CAP rate, or capitalization rate, for investment real estate, is to determine the sales price. If you have already purchased the property, then you would simply use the total price you paid for the home including closing costs, etc. If you have not yet purchased the investment property,then use the asking price plus the amount you plan to pay for closing costs, etc.
The second step to figuring the CAP rate for an investment property, is to determine the yearly Net Operating Income (or NOI) for the property. In order to do this, take the monthly rent that you plan to receive for the property and multiply by 12 months. Then take the monthly operating expenses for the property and multiply by 12 months. Subtract the operating expenses from the rent total to obtain the Net Operating Income or NOI. (Remember, when calculating expenses, you need to total all expenses associated with renting the property, including maintenance, HOA fees, reserve fund, management fees, property taxes, homeowners insurance, etc.)
As an example: If you expect to receive $1500/month in rent, your total yearly rent will be $1500 x 12 = $18,000. If your monthly operating expenses are $300/month, then your yearly expenses will total $300 x 12 = $3,600. Subtract the expenses from the rent for a yearly Net Operating Income (NOI) of $18,000 - $3,600 = $14,400. The final step in calculating CAP or capitalization rate for a property is simply to divide the Net Operating Income (NOI) by the sales price. As an example: If you have a yearly Net Operating Income (NOI) of $14,400, and you purchased the property for $150,000, then you have a CAP rate of $14,400/$150,000 = .096 or just over 9% CAP Rate.
In my next article, I will discuss how to determine a target CAP rate for your investment properties.
If you would like more information on the Las Vegas rental real estate market or investing in Las Vegas properties, please contact me.
Glenn Plantone
702-769-9872
[email protected]
Comments (8)
Scott; You are correct...however we sell all of our properties with long term renters or lease option tenants already under contract and occupying the property. This enables our investor clients to generate immediate cash flow and avoid worrying about vacancy for 3-5 years. If our investors do experience a vacancy we use our waiting list of potential tenants to fill it immediately. We have dozens of clients who can testify to how well this system works. Thanks for the comment!
Glenn Plantone, over 12 years ago
Cap rates take into account a % of vacancy as well. If it's a single unit and it is vacant, you have no NOI,because you have no income and therefore no cap rate. You can have a proposed or "going out" cap rate (after lease up) but the "going in" cap rate would be 0% or less than 0% if it is a single unit and is vacant.
D. Scott Smith, over 12 years ago
Jon - Great post on explaining Cap rates. I sell only single family units here in Memphis and always include a Net ROI in all my analysis for cash purchasers looking for long term hold. Although we don't call it a CAP rate, it is essentially the same thing using a very similar formula. Understanding how to properly calculate your costs and include ALL costs is always the challenge especially when beginning. Good job Chris
Chris Clothier, over 14 years ago
Cole, I think CAP rate can work on residential, but typically people do not include all expenses. The calculation will work better on a portfolio of homes as opposed to a few SFRs, or especially just one.
Jon Klaus, over 14 years ago
Cole, I think CAP rate can work on residential, but typically people do not include all expenses. The calculation will work better on a portfolio of homes as opposed to a few SFRs, or especially just one.
Jon Klaus, over 14 years ago
Glenn, can you estimate expenses on this office building and project cap rates with whatever assuptions you want to include? http://www.biggerpockets.com/forums/32-commercial-real-estate-investing-forum/topics/48545-dallas-class-a-office-tower-sells-for-16-sf
Jon Klaus, over 14 years ago
Glenn, I am sure you are referring to commercial or multi-unit investing? In the past I have had some uneducated Realtors try to give me leads on residential properties at "great" cap rates. This calculation absolutely does NOT work for single family homes. What are you describing?
Cole Haynes, over 14 years ago
Glenn, I am sure you are referring to commercial or multi-unit investing? In the past I have had some uneducated Realtors try to give me leads on residential properties at "great" cap rates. This calculation absolutely does NOT work for single family homes. What are you describing?
Cole Haynes, over 14 years ago