What You Need to Know About Cap Rates
What is a cap rate as it relates to real estate property investing? Cap rate stands for Capitalization Rate which essentially means the rate of return (income) the property is expected to generate, as it applies to investment properties. What an introduction! For those of us who are not real estate market vocabulary pros, let’s try to break this definition of cap rates down to be easily understood.
To start, the capitalization rate is the equivalent of the net operating income which means the same thing as, the current market value. Net operating income (NOI) is the property’s cap rate.
To put this into a scenario, if you were to purchase an investment property and were expecting say, a 10% return in profit, how much would you be willing to spend for that property? The intention of the Cap Rate is to estimate what the investor’s potential return will be on that investment property.
If you were looking to start off in the investment industry on a small scale, you may start with a $100,000 property. You are looking to receive about $10,000 in return every year so your cap rate would be 10%. Because, 10% is equivalent to $10,000 in return on a $100,000 property. Make sense?
Whatever you are estimated to make in return annually gets put into a percentage which is your cap rate. This brings up the question....what is a good cap rate? Well, each market is different and it depends on what the value of the investment is in your market area. The value is in the formula to get the cap rate. In other words, the cap rate comes from the value of the property and the earnings that property will receive in the current market.
Okay, so breaking down cap rates makes for long sentences but really, cap rates are not as complicated as they sound. For any and all questions concerning real estate investing in Contra Costa County, contact your local Irvin Team.