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Cap rate

Cap rate

What is Cap rate?

The Cap Rate, also known as the Capitalization Rate, is an important metric that helps investors understand how much of the initial investment would be returned each year. In other words, it determines the expected rate of return on a property investment. Because the Cap Rate is calculated by the NOI normalized by the current market value of the home, property investors to compare similar properties with cap rate.

How do I calculate the Cap rate?

\[ {Net \, operating \, income (NOI) \over Current \, market \, value } = Cap \, Rate \]


Examples

If a property is currently worth $150,000 and the net operating income $1200/month, then the cap rate is 9.6%. (1200*12)/150000

Cap rate considerations

Though knowing the property's cap rate is an important number to know when evaluating opportunities, there are a few things to note:

  • Different investors may have different definitions of "cap rate" 
  • Your net operating income can be higher if there are more amenities or if you increase your revenue.
  • The cap rate may shift if the property's current market value changes. When there are times of volatility (eg. recession), valuation models may be inaccurate.
  • You can use the previous years’ cap rates of the property to estimate how the property will perform in the future. High cap rates may imply higher risk that's rewarded by higher returns. Low cap rates may imply lower risk with lower returns.

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