What is Cap Rate?
Cap rate (capitalization rate) is a crucial real estate metric used to evaluate investment properties. It helps investors assess potential returns by comparing a property's net operating income to its market value. Understanding how to calculate cap rate is essential for making informed decisions about property acquisitions, comparing different investments, and estimating potential profitability. This metric is particularly valuable in commercial real estate analysis and portfolio management.
Cap Rate Calculator
Cap Rate Formula
The cap rate formula is: Cap Rate = (Net Operating Income / Property Value) × 100%
Calculation Process
| Step | Description | Example |
|---|---|---|
| 1 | Determine annual NOI | $120,000 |
| 2 | Find current property value | $1,500,000 |
| 3 | Divide NOI by Value | 120,000 ÷ 1,500,000 = 0.08 |
| 4 | Convert to percentage | 8% Cap Rate |
Advantages & Disadvantages
Advantages:
- Quick comparison tool for different properties
- Simple calculation with basic financial data
- Helps assess investment risk levels
- Useful for market trend analysis
- Standardized metric across real estate markets
Disadvantages:
- Doesn't account for financing costs
- Ignores future value appreciation
- Not suitable for value-added properties
- Vulnerable to NOI inaccuracies
- Doesn't consider tax implications
FAQs
What is a good cap rate?
A good cap rate typically ranges between 4-10%, depending on location and property type. Urban areas often have lower cap rates due to higher demand, while rural properties may offer higher rates. Always compare with local market averages.
How accurate is cap rate?
Cap rate accuracy depends on reliable NOI and property value data. While useful for quick comparisons, it shouldn't be the sole decision-making factor. Combine with other metrics like cash-on-cash return for comprehensive analysis.