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Rental Property CAP Rates: What to Know


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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