Real Estate Cap Rate Calculator
Calculate the Capitalization Rate to evaluate the profitability of an investment property.
What is a Real Estate Capitalization Rate?
The Capitalization Rate, commonly known as the Cap Rate, is the most fundamental "rate" used by real estate investors to assess the potential return on an investment property. Unlike a mortgage interest rate, which measures the cost of borrowing, the Cap Rate measures the property's intrinsic ability to generate income relative to its market value.
How the Rate is Calculated
The formula for the Cap Rate is straightforward but relies on accurate data regarding the property's financial performance:
Cap Rate = (Net Operating Income / Current Market Value) × 100
- Gross Income: The total potential rent collected if the property is 100% occupied.
- Vacancy Loss: The income lost when units are empty or tenants fail to pay.
- Operating Expenses: Costs required to run the property, including property taxes, insurance, maintenance, and management fees (excluding mortgage payments).
- Net Operating Income (NOI): The remaining cash flow after all operating expenses are paid.
Example Calculation
Imagine a multi-family property valued at $1,000,000. It generates $100,000 in annual gross rent. After accounting for a 5% vacancy rate ($5,000) and $25,000 in operating expenses, the Net Operating Income (NOI) is $70,000.
In this scenario, the calculation would be: ($70,000 / $1,000,000) × 100 = 7.0% Cap Rate.
Why the Cap Rate Matters
Investors use this rate to compare different real estate opportunities quickly. A higher Cap Rate usually indicates a higher potential return but often comes with higher risk (such as a property in a declining neighborhood or an older building requiring significant repairs). Conversely, a lower Cap Rate typically indicates a "safer" investment in a high-demand, stable location.