cap rates

:-\ hey i have a question…i keep seeing cap rates when investment properties are for sale, what exactly does cape rate mean?

thanks,

wendy

The Capitalization Rate or Cap Rate is a ratio used to estimate the value of income producing properties. Put simply, the cap rate is the net operating income divided by the sales price or value of a property expressed as a percentage.

Cap Rate = (Net Operating Income / Market Value) x 100

Joe

FYI - there is a link to your left “Investing Glossary” and another “Investing Abbreviations” that contain a lot of the terms used in REI!

Keith

I have books and have been to the glossary.

Could someone give an example using a hypothetical piece of property, and then plug in the calculations? Thanks in advance.

Also, a concern of mine if performing the Cap Rate using correct numbers, when deciding to buy a piece of residential property (house) to rent out. I have to do this right. If I don’t, I’m in trouble, and my mentors are hesitant to be firm when it comes to this.

Thanks.

Capitalization Rate (CAP Rate)

In real estate appraisal, capitalization is the process of converting income, in the case of real estate net rental income, to a property value. The capitalization rate or CAP Rate for short, is the ratio of yearly net income to the property value. For example, if you purchase an investment property for \$120,000 dollars and can generate \$1,000 per month after all operating expenses (before debt service), then the CAP Rate would be \$12,000 divided by \$120,000 or 10 percent. This means it will take approximately 10 years to recoup the property value in net rental income assuming the rent stays the same.

In general, the lower the CAP Rate the better if you are selling and the higher the CAP Rate the better if you are buying. However, make sure the neighborhood is good and the property is in decent condition. CAP Rate does not help if the property is declining in value.

Thank you,

Very helpful. But basically the cap rate will be changing with rents and appreciating value so a cap rate is ever hanging correct? And we actually have the ability to change the cap rate…ok i’ve worked it out. Many Thanks,
Wendy