Capitalization rates or CAP RATES are the metrics most commonly used to measure the quality of a real estate investment's return. It is used to evaluate an investment property and show its potential rate of return, helping an investor to decide should he purchase the property or not.
It is calculated by dividing a property's net operating income by the current market value. This ratio, expressed as a percentage, is an estimation for an investor's potential return on a real estate investment.
For example, if a property listed for $1M might generate $100k NOI, then the cap rate would be 10%.
Cap Rate = $100K/$1M
Cap Rate = 10%
Now the question is, what is a good cap rate for an investment property?
It is widely known that a good cap rate is typically higher than the market interest rates for financing or borrowed money. Cap rates can also be seen as a measure of risk and return, a low cap rate should mean the asset is lower risk and higher value; while a higher cap rate reflects a lower price, higher risk and higher return.
But there are several factors that will help you determine whether a property's cap rate is good, acceptable, or poor. They are location, asset type, quality of structure, current market and many other conditions.
An investor might be willing to accept a 5% or lower annual return in a certain city because it is perceived to be a less risky market based on its fundamentals.
Perceived risk can also vary widely between asset types. Multifamily assets consistently have lowest cap rates across markets. Meanwhile, hotel and retail properties tend to have higher cap rates, reflecting higher risk as compared to apartments or "Multifamily" assets.
A "good" cap rate depends on the property itself and the investor's risk tolerance.
To fairly gauge and determine the cap rate and the factors that affects it, expertise and experience in the market is of great help. Our team is a group of outstanding individuals with a combination of property related skills and talents, fueled by our desire to help you achieve your success in investing or selling of properties. Our team is available to answer any questions regarding Cap Rates.