Capitalization (Cap) Rate

Generally referred to as a Cap Rate, rental property owners will use this calculation as a way to determine the potential Rate of Return (RoR) on their real estate investment.

For property and real estate investors, the cap rate will help determine whether a property or real estate will be worth purchasing. The deciding factor could be impacted by a set of metrics, including rates and taxes, operating costs, and other deductions.

Determining Cap Rate

To determine what the cap rate on a property would potentially be, the following basic formula can be used.

Cap Rate = Net operating income / Current market value of the asset

What are net operating expenses?

The total amount owed each month, includes taxes, municipal rates, HOA fees, or maintenance fees.

From this, the investor or buyer can determine whether a property will offer them a higher RoR. Additionally, the higher a cap rate the better, as this means an investor will make a larger net return on their property after all deductions.

It’s important to note, that the cap rate won’t always remain the same, as the market value of the physical property can either decrease or increase over time.

Factors that impact the cap rate:

  • Inflation
  • Rise of operating costs
  • Decrease or increase in market demand
  • Physical supply of property
  • Mortgage repayments
  • Interest rates

It’s advised to calculate the cap rate on a property quarterly or annually to ensure that you as an investor are still making a solid return on your investment.

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