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
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Don Sabinske
Sabinske & Associates Inc.
Don Sabinske, 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
Rainmaker
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Las Vegas Realtor® Listing Agent Dawn Barrier 702-812-4550
Las Vegas Homes For Sale
Prominent Realty Group, LLC

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
Ambassador
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Bob Crane
Forestland Experts! 715-204-9663
Woodland Management Service

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
Rainmaker
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Cathy Bureau
Your Personal Real Estate Concierge
www.GreenHomeRealty.com

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
Rainmaker
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Lloyd Binen
Silicon Valley R since 1976;408-565-8177
Certified Realty Services

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
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Dick Greenberg

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