How to Calculate Capitalization Rate Part 1

By
Real Estate Agent with Keller Williams Realty - Topsfield, MA 92593-B

I found the following discussion on how to determine the Capitalization Rate for a piece of investment property to be helpful for new investors in Real Estate. I hope you enjoy the explanation. I was looking at this information to refresh my knowledge and maybe pick up some new knowledge. 

 

Real estate investors rely upon a variety of types information when negotiating for income producing properties - for instance, the desirability of the property's current location and/or any prospective changes in the neighborhood are two common factors. One crucial piece of information that helps investors make their decision is called the capitalization rate (or "cap rate"). The cap rate (expressed as the ratio of the property's net income to its purchase price) allows investors to compare properties by evaluating a rate of return on the investment made in the property. If you are considering an investment property, then you may want to calculate the cap rate first and then use it to help you make your decision.

 

CALCULATING CAP RATE

 

1

Calculate the yearly gross income of the investment property. The gross income of a piece of investment property will mainly be in terms of rent rolls. In other words, when a real estate investor buys a home, s/he usually makes money from it primarily by renting it out to tenants. However, this isn't the sole possible source of income - miscellaneous income can also accrue from the property in the form of coin-operated vending or washing machines, etc.
  • For example, let's say that we've just purchased a house we intend to rent to tenants at a rate of $750/month. At this rate, we can expect to make 750 × 12 = $9,000 per year in gross income from the property.

 

2

Subtract the operating expenses associated with the property from the gross income. Any piece of real estate comes with operating costs. Usually, these are in the form of maintenance, insurance, taxes, utilities, vacancy costs, and property management. Use accurate estimates for these numbers and subtract them from the gross income you found above. This will find the property's net income.
  • For example, let's say that, after having our rental property appraised, we find that we can expect to pay $900 in property management, $450 in maintenance, $710 in taxes, and $650 in insurance per year for our property. 9,000 - 900 - 450 - 710 - 650 = $6,290, our property's net income.
  • Note that the cap rate doesn't account for the property's business expenses - including the purchase costs of the property, mortgage payments, fees, etc. Since these items reflect the investor's standing with the lender and are variable in nature, they adversely affect the neutral comparison that the cap rate is meant to deliver.

 

3

Divide the net income by the property's purchase price. The cap rate is the ratio between the net income of the property and its original price or capital cost. Cap rate is expressed as a percentage.
  • Let's assume we purchased our property for $40,000. Given this information, we now have everything we need to know to find our cap rate. See below:
    • $9000 (gross income)
    • -$900 (property management)
    • -$450 (maintenance)
    • -$710 (taxes)
    • -$650 (insurance)
    • =$6290 (net income) / $40000 (purchase price) = 0.157 = 15.7% cap rate
 

Calculate the yearly gross income of the investment property. The gross income of a piece of investment property will mainly be in terms of rent rolls. In other words, when a real estate investor buys a home, s/he usually makes money from it primarily by renting it out to tenants.[3] However, this isn't the sole possible source of income - miscellaneous income can also accrue from the property in the form of coin-operated vending or washing machines, etc.

  • For example, let's say that we've just purchased a house we intend to rent to tenants at a rate of $750/month. At this rate, we can expect to make 750 × 12 = $9,000 per year in gross income from the property.

Calculate the yearly gross income of the investment property. The gross income of a piece of investment property will mainly be in terms of rent rolls. In other words, when a real estate investor buys a home, s/he usually makes money from it primarily by renting it out to tenants.[3] However, this isn't the sole possible source of income - miscellaneous income can also accrue from the property in the form of coin-operated vending or washing machines, etc.

  • For example, let's say that we've just purchased a house we intend to rent to tenants at a rate of $750/month. At this rate, we can expect to make 750 × 12 = $9,000 per year in gross income from the property.
Posted by

I pray that God our Father and the Lord Jesus Christ will be kind to you and bless you with peace

2 Thessalonians 1:2

 

Doug Dawes REALTOR®, AWREP, LMC

Broker Sales Associate

KELLER WILLIAMS REALTY - Topsfield/Newburyport

49 Main Street
Topsfield, MA 01983
 978-887-3995  ~ Office
 978-270-3037  ~ Cell
 DougDawes@KW.com

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Rainmaker
4,432,217
Gita Bantwal
RE/MAX Centre Realtors - Warwick, PA
REALTOR,ABR,CRS,SRES,GRI - Bucks County & Philadel

Thank you for the post. I will bookmark it and use it . 

Oct 01, 2018 05:31 AM #1
Rainmaker
776,095
Doug Dawes
Keller Williams Realty - Topsfield, MA - Georgetown, MA
Your Personal Realtor®

Good Morning Gita Bantwal 

Thank you for reading and bookmarking. Tomorrow will contain part 2 of the discussion

Oct 01, 2018 05:57 AM #2
Rainmaker
3,020,321
Scott Godzyk
Godzyk Real Estate Services - Manchester, NH
One of the Manchester NH's area Leading Agents

I like the graphics. I do alot of investment property and find myself filling out these reports often. Have a good Monday Doug Dawes 

Oct 01, 2018 06:29 AM #3
Rainmaker
415,306
Suzanne Strickler
Realty Mark Associates - Havertown, PA
School is never out for the Succesful.

When working with investors, I found being able to calculate the cap rate is one skill they expect. You explained it well. 👍🏻

Oct 01, 2018 06:52 AM #4
Rainmaker
776,095
Doug Dawes
Keller Williams Realty - Topsfield, MA - Georgetown, MA
Your Personal Realtor®

Hi Scott Godzyk 

Monday was a good day. I don't do a lot of multi's but find it important to know about cap rates

Oct 02, 2018 06:32 AM #5
Rainmaker
776,095
Doug Dawes
Keller Williams Realty - Topsfield, MA - Georgetown, MA
Your Personal Realtor®

Hi Suzanne Strickler 

Yes, they do expect it and it does help as 1 of the tools in establishing price

Oct 02, 2018 06:33 AM #6
Rainmaker
2,704,800
Lisa Von Domek
Lisa Von Domek Team - Dallas, TX
....Experience Isn't Expensive.... It's Priceless!

Hello Doug Dawes Great information and fun timing...I just went through this information in a recent Commercial class.

Oct 02, 2018 08:08 PM #7
Rainmaker
776,095
Doug Dawes
Keller Williams Realty - Topsfield, MA - Georgetown, MA
Your Personal Realtor®

Good Morning Lisa Von Domek 

It is good information to know.

Oct 03, 2018 06:37 AM #8
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Rainmaker
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Doug Dawes

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