You will stumble upon a wide variety of concepts in the world of rental properties, and yes, sometimes they would be too hard to digest, more if you’re only now getting the hang of it because you need to sell, rent, or find a new property as soon as possible. Real estate investors might be the only ones that completely understand the complexity of the combination of terms you can hear in the world of real estate; but if you want to be up to date with at least the basics of rental property, you’ll find that terms such as “good cap rate rental property” comes out a lot. Today we are going to focus on this term. “What is it?” “How to calculate it?” and other questions are approached in this article. Here is the basic information on good cap rate rental property you need to know.
What is Cap Rate?
Cap rate is all about Return on Investment (ROI), which means that it measures the rental income generated by income properties, such as their prices, and their operating and rental expenses. All with the only goal of getting the most accurate measure of a property’s profitability. The return on investment can be measured in two ways: cash on cash return and through cap rate.
Cap Rate, short for capitalization rate, is a return on investment measurement of rental properties regardless of how they were financed. The cap rate is based on the rental income, rental expenses, and value of a rental property. Consistently, this tells real estate investors how much profit they’re receiving out of the property’s value, and it will always be depicted as a percentage. The capitalization rate is essential to make money in real estate, regardless of the rental strategy.
How to Calculate the Cap Rate?
The capitalization rate is calculated with the net operating incomes and recent sales prices of comparable properties. The first thing you have to do is get the recent sales price of a similar income property, so you can determine the net operating income of that property and finish by subtracting all operating expenses except the mortgage. Here’s an example from the website The Balance, which can help you calculate the cap rate formula:
If this is hard to swallow then stop worrying, as you can calculate the cap rate in this calculator.
What Affects a Good Cap Rate?
As with most properties, location still impacts the value of what you’re selling, renting, or buying; this is why the rental strategy can change the dimension of what is a good cap rate. For instance, Airbnb rentals tend to generate higher rent compared to traditional rentals, while these, on average, cost less in the rental expenses. Cases like these can make the range of a reasonable cap rate be unlike depending on the rental strategy. Another factor that’s tangled in the outcome of a good cap rate is the property type, which means that multifamily rentals can have higher cap rate than single-family homes; also, ranges can vary from long-term to short-term rental properties.
Why is Cap Rate So Important?
The three main reasons are:
- The return on investment – The Capitalization Rate is one of the forms of return on investment (ROI). Real estate investors need to determine how beneficial the income of your property is.
- The comparing of investment properties is vital to distinguish between investment properties based on expected profitability.
- The estimated payback period is needed so you can know if the cap rate will fully cover the property payment. How do you estimate the payback period? You only have to divide 100 by the cap rate of the property; for example, if the payback period of the property is 12 years, the formula is 100 divided by 12.
The world of real estate is complicated, but once you start going deeper into concepts, there may be a chance you can have it all under control. In case all this still turns your head into a mess, don’t hesitate to call agencies to help you manage your rental property or guide you through the process.