Cap Rate Calculator - Understanding Real Estate Cap Rates
Posted by Grant Cardone
One of the most used calculations you’ll see in real estate investing is a capitalization rate (cap rate). But what does it really mean, and what should you use it for? Learn what goes into a cap rate and use our cap rate calculator to find out what the cap rate is for an investment property you’re looking at, and what price would give you the cap rate you’re looking for.
Choosing the right investment property is all about how much money you will receive compared to how much you invest. A good investment has the right balance between the expected income and the amount of risk.
The balance for each investor is different. Making the right investment decisions involves looking closely at each property and choosing one that fits all of your criteria. A very common thing investors look at is a property’s cap rate.
What is a cap rate?
A capitalization rate (cap rate) is the percentage of the purchase price an investment property currently generates in net income. The cap rate is calculated before taking any loans or loan payments into account.
You can think of a cap rate as the return on investment (ROI) a real estate investment would provide if the property was purchased in cash and the income stayed exactly the same.
For example, if the purchase price of a property is $1,000,000 and the annual net operating income (NOI) is $50,000, the cap rate would be 5% because $50,000 is 5% of $1,000,000.
Why is a cap rate used?
Cap rates give an investor a general idea of how well a property performs. An investor may not spend time analyzing a property with a low cap rate, because they can easily tell it doesn’t provide the income they’re looking for.
The investor will be more likely to take a deeper look into a property that has a cap rate within the range they’re looking for.
A cap rate can also determine how much an investor wants to pay for a property. If your criteria involves a certain cap rate, you can figure out what the price would have to be to get that cap rate based on the current net income.
Lenders also look at cap rates when they’re underwriting a loan. It will help the lender decide if the income from the property is enough to cover the loan payments. It will also tell them what loan to value ratio they can offer.
Syndication RegulatCap rate calculator
If you already know a property’s NOI, you can just enter it below with the purchase price to see the cap rate.
You can also calculate the NOI here by entering the gross income and operating expenses.
Are you trying to get an idea of what your investment property is worth? Or figuring out what you want to offer on an investment?
Just click the price tab and enter the NOI and the market cap rate. We’ll show you what the sale price will have to be to get that rate.
What is a good cap rate?
Deciding what a good cap rate is depends on many things. It depends on what your overall investment goals are, the property type, where it’s located, and many other things.
Ultimately, a good cap rate is one that provides a better return that other similar investments. If you’re looking at a class C apartment building in an area with declining property value, a good cap rate will be much higher than the cap rate of a class A apartment building in a growth market.
For instance, Cardone Capital prefers investing in Class A properties in growing markets because they offer good returns with minimal risk. Naturally, the cap rate on these will be lower than a property with a high level of risk.
High risk properties may be appealing because of the potential returns, but there’s a higher chance you could lose everything. The chances of any single property becoming a loss isn’t very high.
However, if you’re growing a portfolio of multiple properties, the chances of one high risk property becoming a loss is significant.
If just one property in your portfolio goes belly up, that ruins the ROI across your whole portfolio. Not to mention the high fluctuations in occupancy and the higher maintenance and repair costs going out each year.
To get an idea of a good cap rate, you can look at average cap rates, and other investment metrics for the properties Cardone Capital chooses to invest in.
Multifamily cap rate:
What affects cap rates?
Cap rates fluctuate just like the interest on bonds or CDs, or the interest the bank charges for a mortgage. These changes fluctuate based on the market and the supply and demand. When many buyers are competing over the same properties, prices naturally go up. A higher price means a lower cap rate.
If sellers are having a hard time finding buyers for their investment properties, they usually start lowering the price. A lower price means a higher cap rate.
Mortgage interest rates also play a role in cap rates. If mortgage rates increase, that means the difference between what an investor is paying for the money, and what they’re getting from the investment is smaller. This means they’re making less money.
Naturally, investors will demand higher cap rates which means lower sale prices.
Therefore it’s important to get attractive interest rates from your lender. The lower you’re paying in interest, the less vulnerable you are to changing rates and the higher your cash flow will be.
If you’re not able to get attractive interest rates, you might partner with an investor who can. Interest rates can have a big impact on the cash flow you receive every month and the equity you build.
The amount of new construction also affects cap rates. If more units are being built nearby, the demand for leasing apartment units may decrease. This can cause a higher vacancy rate and a lower rent rate sometimes.
Smart investors can recognize which areas are ripe for development and structure their investment strategy around the assumption that there will be additional units nearby.
How important is the cap rate?
A cap rate is just one thing to look at in an investment property. The cap rate gives you the ROI based on the current income and the assumption you’re paying cash. The reality is the NOI will change, you’ll leverage the investment, the real estate will appreciate, and you’ll build equity.
These factors play a huge role in the total return you’ll earn on your investment. Other factors you need to look at in terms of ROI.
- Cash-on-cash return. This is the amount of cash in your pocket each year, after loan payments, compared to the amount of cash you put into the deal. This takes into account the loan on the property.
- Internal rate of return (IRR). The IRR is a calculation that gives a better idea of what the ROI will be over the full term of the investment, instead of just the current time period like a cap rate
- Equity multiple. You’re paying down the principal balance on your loan each month with the rental income. As the principal balance decreases, the equity in the property increases. When it comes time to sell, you’ll get more back than the cash you initially put into it. You may put $1,000,000 into an investment, you may get $150,000 back if you sell it in five years.
Is a good cap rate always a good investment?
The simple answer is no. It is a factor in determining if a property will generate cash flow, but does not tell you if an investment is good or not.
The most important things to look at when choosing an investment are:
- Number of units. The more units a property has, the easier you can increase the overall income.
- Cash flow. The property must have positive cash flow from month one. It has to be a good income producer.
- Location. Must be in a great location that will continue to improve. You can’t pay too much for a great location.
- Friendly debt. Banks must want to lend on it and be competitive with financing terms and interest rates.
- Competitive market. You want to bid on properties that have a lot of interest. If nobody else wants it now, nobody else will want it when you sell in 5 of 10 years.
How to calculate a cap rate
A cap rate has a simple calculation. The most important thing to do before you calculate the cap rate is calculate the property’s net operating income.
Not the NOI the seller or broker is advertising, but the NOI you calculate after reviewing the financials. You need to watch out for sellers adding back expenses that shouldn’t be, or basing it off of a projection for the next 12 months.
You’ll look at the most recent annual gross income, subtract operating expenses (minus depreciation, interest expense, and anything else that should be added back).
Gross income - operating expenses = NOI
You’ll divide the NOI by the purchase price.
NOI / purchase price = cap rate
Since the answer will come out as a decimal, you’ll convert that to a percentage. Either remove the decimal point or multiply the number by 100.
Let’s look at an example:
Purchase price: $5,000,000
$300,000 / $5,000,000 = 6% (.06)
What a cap rate should mean to you
Calculating the cap rate is an important thing to do when looking at a real estate investment, but it definitely should not be the only metric used to make a purchase decision. There are a lot of other things that add up to tell the complete story of an investment property, you consider all of them before making your offer.
Knowing what a cap rate is will help you pick the right properties to look at, but make sure you can check all the boxes on a property you’re looking at. If you have specific criteria, you’re better being patient and waiting for the right property than jumping into something that’s not right for you.
Should you decide investing in individual properties is not for you, then investing with Cardone Capital will give you access to a professional team that analyzes hundreds of deals and invests in those with a well-balanced risk and reward (earnings).
Our offerings under Rule 506(c) are for accredited investors only.
For our current regulation a offering, no sale may be made to you in this offering if the aggregate purchase price you pay is more than 10% of the greater of your annual income or net worth. Different rules apply to accredited investors and non-natural persons. Before making any representation that your investment does not exceed applicable thresholds, we encourage you to review rule 251(d)(2)(i)(c) of regulation a. For general information on investing, we encourage you to refer to www.investor.gov. Our offering circular, which is part of the Offering Statement, may be found at sec.gov or on our website www.cardonecapital.com/offering-1.