Cap Rate Calculator
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Gross Scheduled Income (Annual):
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Effective Gross Income:
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Net Operating Income (NOI):
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Capitalization Rate:
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Understanding Capitalization Rate in Real Estate Investing
The Capitalization Rate, commonly known as Cap Rate, is one of the most fundamental metrics used in commercial and residential real estate investing. It helps investors assess the profitability and return potential of an investment property independent of financing.
How to Calculate Cap Rate
The Cap Rate formula is straightforward but requires accurate inputs regarding the property's income and expenses. The formula is:
Cap Rate = Net Operating Income (NOI) / Current Market Value
Step-by-Step Calculation:
- Calculate Gross Annual Income: Sum up all rental income and other income sources (like laundry or parking fees).
- Subtract Vacancy Losses: Adjust the gross income by the expected vacancy rate (e.g., 5-10%) to get Effective Gross Income.
- Determine Net Operating Income (NOI): Subtract all annual operating expenses (taxes, insurance, maintenance, property management) from the Effective Gross Income. Note: Do not include mortgage payments.
- Divide by Property Value: Divide the NOI by the purchase price or current market value.
What is a Good Cap Rate?
There is no single "good" Cap Rate, as it varies significantly by location, property class, and the current economic environment. However, general guidelines include:
| Cap Rate Range | Risk Profile | Typical Property Type |
|---|---|---|
| 3% – 5% | Low Risk | Class A properties in prime locations (e.g., NYC, SF). High appreciation potential but lower immediate cash flow. |
| 5% – 8% | Moderate Risk | Class B properties in stable suburban areas. Balanced cash flow and appreciation. |
| 8% – 12%+ | Higher Risk | Class C/D properties or rural areas. High cash flow but potentially higher maintenance and vacancy issues. |
Why Exclude Mortgage Payments?
Cap Rate is designed to calculate the intrinsic return of the property itself, assuming an all-cash purchase. This allows investors to compare different properties on an apples-to-apples basis without the distortion of varying loan terms, interest rates, or down payment amounts. To analyze returns including debt service, investors use the Cash-on-Cash Return metric.
Factors Influencing Cap Rates
- Location: Prime locations command lower cap rates due to higher demand and lower risk.
- Asset Class: Multifamily, industrial, retail, and office spaces all trade at different average cap rates.
- Interest Rates: As borrowing costs rise, investors typically demand higher cap rates (lower prices) to maintain profitability.