Often times we will get a buyer of an investment property....lots of questions, and mostly good ones. One good question that keeps coming up, especially with newer investors...What is the Cap Rate? What cap rates are on the recent sales? So, here is a definition of a Cap Rate...one of the best that I have read....and I think it is from one of the real estate investment text books...
The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties.The cap rate is the net operating income divided by the sales price or value of a property expressed as a percentage. Investors, lenders, and appraisers use the cap rate to estimate the purchase price for different types of income producing properties, which is a guideline for a new investor. A market cap rate is determined by evaluating the financial data of similar properties which have recently sold in a specific market. It provides a more reliable estimate of value than a market Gross Rent Multiplier since the cap rate calculation utilizes more of a property's financial detail. The GRM calculation only considers a property's selling price and gross rents. The Cap Rate calculation incorporates a property's selling price, gross rents, non rental income, vacancy amount and operating expenses thus providing a more reliable estimate of value. These are all key factors that a buyer should consider in the decision making process.
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