Investors, are you keeping an eye on rental
property cap rates? If not, you might want to start incorporating them into
your business strategies.
If you’re not familiar with rental property
cap rates, here’s a basic review of rental property cap rates 101. Let’s jump
in:
Cap
Rates Defined
Capitalization rates, or cap rates, are a
simple equation that looks at a property's overall potential by making a loose
prediction on the deal’s baseline ROI.
Ultimately, this helps to determine if a
property purchase is a strong investment opportunity… or not. Employing cap
rates within your investment strategy can prevent investors from moving forward
with dead-end deals and strengthen their portfolios with winning assets.
Cap rates are not definite as they’re subject
to change, however, that doesn’t mean they’re not worth taking a look at.
Investors need to keep in mind the fact that cap rates cannot possibly predict
the totality of a real estate transaction. Every real estate deal is subject to
influence from a number of external factors, such as a shift in market trends
or other incalculable disruptors.
Many experts compare watching cap rates to
watching stock market ebbs and flows - it needs to be taken with some
discretion, but it can help gear investors in the right direction.
To
Invest or Not to Invest - Cap Rates Coming into Play
In real estate, a cap rate is basically a tool
used to vet the deal. They’ll be used by investors who are deciding whether or
not to pursue a deal, whether it be buying or selling. Cap rates are especially
helpful when dealing with rental properties, multifamily, commercial real
estate assets, and townhouses.
The
Formula for Calculating Cap Rates
To figure out a property’s cap rates, you’ll
need to divide the current market value by the net operating income and then
multiply the sum by 100. Here’s an extrapolated version of the equation so you
can easily plug in your specific values:
(Net Operating Income / Current Market Value)
x 100 = Cap Rate
Thanks to the internet, you don’t necessarily
need to do all of the hard work yourself. If you’re looking to get the cap rate
calculated by an automated system, just type ‘cap rate calculator’ into your
search engine and click on one of the equation generators.
The
Golden Ratio: The CAP Rate to Look Out For
Not all capitalization rates are considered
equal. In fact, the ideal cap rates that investors should look out for are
hovering around the 4% region. This rate is considered as a safe spot for
investors, as it promises a solid return while still providing some
wiggle-room.
In general, a low cap rate essentially points
to a low risk. When considering cap rates, the smaller the number, the better
the outlook. Again, it’s important to note that cap rates aren’t set in stone -
they don’t promise a successful deal, they only help point investors in a
safe-guarded direction.
Understanding rental property cap rates is a
wonderful way to enhance the real estate investment process. Don’t fall into an
investment pitfall - weigh a deal’s pros and cons with cap rates.
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