FAQ#5 - What's a CAP Rate and Why Do I Care?

By
Real Estate Broker/Owner with New Paradigm Partners LLC EB #1326335

If you're actively investing in real estate, you know that a cap rate is a measure of the rate of return you might expect from an investment property. Simply stated, it is the annual net operating income divided by the market value of the property:

CAP Rate

As an example, suppose that you purchased a rental home for $200,000, and that based on a monthly rent of $1500, your annual net income was $15,500 after expenses. Your cap rate would be 7.75%. Note that in figuring cap rates, net operating income is defined as earnings before depreciation and interest expense.

Cap rates can also provide some insight into valuing a property based on its income generation potential:

Market Value

Cap rates are simple enough, but that's also their limitation. While CAP rates can be easily and quickly generated and are good for quick comparisons between income properties, they have limited utility as a tool for evaluating the real worth of an investment.

EvaluationIf you have found an investment property to which you would like to give some serious consideration, let us know. We have a very useful investment spreadsheet that we'd be happy to share with you. It's easy to use and will give you a much more detailed look at how an investment may perform, based on your input of detailed property and financial data. And while it's a bit more effort than simple division, it will give you the kind of information you need to determine how a potential investment will fit with your criteria and goals.

Posted by
Mary & Dick

Mary & Dick Greenberg
New Paradigm Partners LLC
2601 S. Lemay Ave. #41
Fort Collins, CO 80525
970-689-4663
www.maryanddick.com

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Rainmaker
552,574
Gary Frimann
Eagle Ridge Realty / Signature Homes & Estates - Gilroy, CA
California Broker and REALTOR

Great post for attracting attention to investment properties!  I agree with Dick above, as it provides a great call to action!  Good one.

May 30, 2012 02:55 PM #2
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Suzanne McLaughlin
Sabinske & Associates, Inc. (Albertville, St. Michael) - Saint Michael, MN
Sabinske & Associates, Realtor

i actually used to work with investors.  And, the cap rate was standard fare.  New investors need to be taught the ropes.to

May 30, 2012 03:03 PM #3
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Lenn Harley
Lenn Harley, Homefinders.com, MD & VA Homes and Real Estate - Leesburg, VA
Real Estate Broker - Virginia & Maryland

HA!  I learned this in a CRS class.  Never used it but the insight is helpful.  No learning is wasted. 

You gave very easily understood examples.

May 30, 2012 03:17 PM #4
Rainmaker
654,112
Evelyn Kennedy
Gallagher & Lindsey, Alameda, California - Alameda, CA
Alameda, Real Estate, Alameda, CA

Dick:

Thanks for the info.  When my investors ask about cap rate, I have to go to my notes and look the calculation up.  Obviously, most of my clients are home buyers and seller not investors.  I should memorize that figure.  I may have to take a pop quiz on cap rate sometime.

May 30, 2012 04:05 PM #5
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Dick Greenberg
New Paradigm Partners LLC - Fort Collins, CO
Northern Colorado Residential Real Estate

Hi Everyone and thanks for commenting. Our investment spreadsheet is a pretty cool tool, and I'd be happy to share it. If you'd like a copy, just e-mail me and I'll send it to you.

May 30, 2012 04:10 PM #6
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Christine Donovan
Donovan Blatt Realty - Costa Mesa, CA
Broker/Attorney 800-610-7253 DRE01267479 - Costa M
Mary and Dick - I think this is a term where many don't know what it is though they've heard of it
May 30, 2012 05:05 PM #7
Rainmaker
1,098,099
Scott Godzyk
Godzyk Real Estate Services - Manchester, NH
One of Manchester NH's Leading Agents

Good Evening Dick, Congratulations on the featrured blog. Cap rates are important to seasoned investors and should be important to anyone looking to invest. Great subject you do not hear about much in blogs.

May 30, 2012 05:17 PM #8
Rainmaker
1,200,611
John Pusa
Sellstate Pacific Realty - Glendale, CA
Your All Time Realtor With Exceptional Service

Dick - Thank you for sharing detailed quality information on what's a cap rate and why do I care.

May 30, 2012 06:05 PM #9
Rainmaker
1,071,316
Endre Barath, Jr.
Berkshire Hathaway HomeServices - Beverly Hills, CA
Realtor - Los Angeles Home Sales 310.486.1002

Dick I so loved this post, too many people are hung up on CAP rates and they do not realize that there are many variables on how you calculate the rate there are many other variables to consider!

May 30, 2012 06:18 PM #10
Rainmaker
601,527
Joy Daniels
Joy Daniels Real Estate Group, Ltd. - Harrisburg, PA

I got this info from one of my Broker Classes - very good to know if you want to own investments.  Thanks for sharing.  I bookmarked it for future reference. 

May 30, 2012 06:51 PM #11
Rainmaker
1,044,305
Kevin B. Tolbert PA Team
Keller Williams Realty of Port Saint Lucie - Saint Lucie West, FL
New Home Construction and Luxury Specialist!

Way to show them Dick.  And you forgot the part where if you are getting a great CAP RATE NOW and the market is the hottest in the country with a 10% per month growth in equity, now your cap rate becomes 120% per year and that means your REALTOR is your new best friend for life.

Call me and I can show you some CRAZY NUMBERS lately here in Port St Lucie. 

May 30, 2012 07:36 PM #12
Rainmaker
1,066,564
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services

An interesting post.  I would love to see your spreadsheet. This is great information and I was not aware of this.

May 30, 2012 07:51 PM #13
Rainmaker
727,543
David Shamansky
US Mortgages - David Shamansky - Highlands Ranch, CO
Creative, Aggresive & 560 FICO - OK, Colorado Mtgs

Again another killer post and I have to ask myself why I am not sending you some of my customers in the No CO area?

That WILL change my friend!

Peace and congrats on yet another well deserved star!

May 30, 2012 08:38 PM #14
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Kathleen Daniels
KD Realty - 408.972.1822 - San Jose, CA
San Jose Homes for Sale - San Jose Probate Agent

Dick,  This reminds me of Broker Exam course work.  I don't use it much.  However, I recently had an investor client who is short selling a property ask me what CAP rate is.  Congrats on the Feature.

May 30, 2012 10:26 PM #15
Rainmaker
400,529
June Tassillo
Owner/Broker RE/MAX Elite Realty - Franklin, NC
Let me help you with the next phase of your life!

Hi Dick,  That was as simple as it gets.  I too learned this in Real Estate school but don't use it very often.  Its very important to get all the facts like real expenses for the cap rate to come out correctly.  I would like a copy of your spread sheet method.  Thanks in advance! 

Congrats on your feature. 

May 31, 2012 06:29 AM #16
Rainmaker
610,256
Don Sabinske
Don Sabinske, Sabinske & Associates Inc. - Zimmerman, MN
Sabinske & Associates Inc.

I used to do some commercial and multi-family properties.  This is great information for realtors who need to bone up on their skills to expand their business. 

May 31, 2012 07:51 AM #17
Rainmaker
278,928
Las Vegas Real Estate Listing Agent Dawn Barrier 702-812-4550
Prominent Realty Group, LLC - Las Vegas, NV
Las Vegas Homes For Sale

Great post!  I really like this part regarding cap rate: they have limited utility as a tool for evaluating the real worth of an investment

May 31, 2012 09:09 AM #18
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Bob Crane
Woodland Management Service - Stevens Point, WI
Forestland Experts! 715-204-9663

Thanks Dick, great information whether for an investor or someone selling to an investor.  I will be sending an email regarding the spreadsheet.

Thanks

May 31, 2012 10:30 AM #19
Rainmaker
365,365
Cathy Bureau
www.GreenHomeRealty.com - Alamo Heights, TX
Your Personal Real Estate Concierge

Explaining things as simply as you have clearly indicates your experr understanding. I used cap rates in commercial development but I find in multi-family and smaller  projects people look for cash on cash payback.

Love the series!


Sincerely,

Cathy Bureau
♥X☺X☺X☺♥

May 31, 2012 12:50 PM #20
Rainmaker
338,965
Lloyd Binen
Certified Realty Services - Saratoga, CA
Silicon Valley R since 1976;408-565-8177

Dick,

Terrific explanation of Cap rates.  What percentage of sales in your marketplace are to non-owner occupants?

Can an investor out there break-even with 25% down?   Do you quote a cap rate for Single Family Residences in your marketplace?  We don't.   Nothing capped-out until the '07 crash.  Investors of single family homes--plentiful in the 70s and 80s--were non-existant after about 1990.  Nothing penciled, especially if it didn't appreciate.

In 2008 low-end homes declined 50-60% and provided a reasonable return even without future appreciation.  That's really what put a quick floor under our market and prevented further declines.  Most of the valley homes did not drop that much.  See ya, Dick.

May 31, 2012 06:16 PM #21
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