Rental Property Cap Rate Calculator
Result:
What is Cap Rate?
The Capitalization Rate, or Cap Rate, is a crucial metric used by real estate investors to quickly estimate the potential return on investment for a property. It represents the ratio between the property's net operating income (NOI) and its market value or purchase price. Essentially, it tells you how much income a property generates relative to its cost, before considering financing or income taxes.
How to Calculate Cap Rate:
The formula for Cap Rate is straightforward:
Cap Rate = (Net Operating Income / Property Purchase Price) * 100
Where:
- Net Operating Income (NOI): This is the annual income generated by the property after deducting all operating expenses. Operating expenses typically include property taxes, insurance, property management fees, maintenance, repairs, and utilities (if paid by the landlord). Crucially, NOI does NOT include mortgage payments (principal and interest) or depreciation, as these are considered financing costs and non-cash expenses, respectively.
- Property Purchase Price: This is the total cost of acquiring the property. For new acquisitions, it's the purchase price. For existing properties, it's often considered the current market value.
Interpreting Cap Rate:
A higher Cap Rate generally indicates a potentially higher return on investment and lower risk, assuming all other factors are equal. Conversely, a lower Cap Rate might suggest a lower return or a higher-priced property relative to its income-generating potential. Investors often compare the Cap Rate of a target property to the Cap Rates of similar properties in the same market to gauge its investment attractiveness.
Example Calculation:
Let's consider a rental property:
- Annual Rental Income: $24,000
- Annual Operating Expenses (property taxes, insurance, maintenance, management fees): $8,000
- Property Purchase Price: $300,000
First, calculate the Net Operating Income (NOI):
NOI = Annual Rental Income – Annual Operating Expenses
NOI = $24,000 – $8,000 = $16,000
Now, calculate the Cap Rate:
Cap Rate = ($16,000 / $300,000) * 100
Cap Rate = 0.0533 * 100 = 5.33%
This means the property has a Cap Rate of 5.33%, indicating the potential annual return on the invested capital before financing costs.