Capitalization Rate (Cap Rate) Calculator
What is a Capitalization Rate (Cap Rate)?
The capitalization rate, commonly known as the Cap Rate, is a fundamental metric used in real estate investing to evaluate the profitability and return potential of an income-producing property. It represents the yield of a property over a one-year time horizon assuming the property is purchased with cash.
The Cap Rate Formula
Cap Rate = (Net Operating Income / Current Market Value) × 100
How to Calculate Cap Rate
- Determine Gross Income: Total all rental income and other fees collected from the property annually.
- Calculate Operating Expenses: Include taxes, insurance, maintenance, property management, and utilities. Do not include mortgage payments (debt service) or capital expenditures.
- Find Net Operating Income (NOI): Subtract operating expenses from gross income.
- Divide by Value: Divide the NOI by the current market price or purchase price of the property.
Example Calculation
Imagine you are looking at a multi-family property valued at $1,000,000.
- Annual Gross Income: $120,000
- Annual Operating Expenses: $40,000
- Net Operating Income (NOI): $80,000
Calculation: ($80,000 / $1,000,000) × 100 = 8.0% Cap Rate.
Why is Cap Rate Important?
Cap rates allow investors to compare different real estate opportunities quickly. A higher cap rate usually implies a higher potential return but often comes with higher risk. Conversely, a lower cap rate typically suggests a safer investment in a highly desirable location (like NYC or London) where property values are high relative to the rent they generate.