Understanding Rental Properties Capitalization Rate

Investors are always concerned about cap rates on rental properties they want to purchase in order to determine the property’s investment potential. Cap rates are useful because they give you an idea of what your return on your investment would be if you paid cash. Think of it in simple terms as a percentage rate of how much you will earn on your money each year. Appraisers and lenders also use cap rates when determining property values.

If you are new to investing, don’t be intimidated by the capitalization rate. Cap rates are pretty simple to calculate. The cap rate is the net operating income divided by the property purchase price or market value of the property. For instance, let’s say the property’s net operating expenses are $ 10,000, and the purchase price is 200,000.Your cap rate .05%.

You will also hear the term “market cap rate”.

What this means is you are evaluating the property by reviewing the financial data of similar properties that have sold in the same market area. Savvy investors use this method instead of using the gross rent multiplier (GRM) because it gives them a more accurate number because they are using all the property financial data. If you want to calculate the gross rent multiplier, you can use that as a secondary method. Keep in mind though that the GRM only takes into account the property sales price and the gross rents, while the market cap rate formula looks at both the sales price and gross rents and much more including the non-rental income, vacancies and operating expenses giving you a complete picture.


Cap rates vary depending on the city and neighborhood location of the rental property. Factors you should consider include neighborhood location and desirability, crime statistics and whether there are any redevelopment plans and current condition of the area. The rule of thumb is if you are investing in a high risk area, you want a high cap rate, and you want to purchase the property for the lowest price. Sellers always want the highest price for their property. Understanding the principal of cap rates lets you compare one property to another. If you do your homework first and crunch your numbers, then you will be able to make an intelligent business decision on what to offer for the property that makes sense for your financial plans and goals. Another thing to keep in mind is your actual rate of return may be higher than your cap rate because cap rates are calculated on the theory that you are paying all cash upfront for the property and leverage is the variable factor that makes the difference in your actual rate of return.

Familiarizing yourself with cap rate calculations doesn’t take very long. There is plenty of useful information and investing tools online such as cap rate calculators, books and other resources to help you with the process. For more details feel free to visit – http://www.platinumchoicesinvestments.com

Author is a Real Estate Professional and remains keen on helping out people who want to invest money in Real Estate. If you are looking for a Real Estate Investment Company or Real Estate Investing Opportunity then the author will be of great help to you. For more details feel free to visit – http://www.platinumchoicesinvestments.com

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