Those who are new to the process of real estate investment may feel a bit overwhelmed by the various complexities. It can be tough to decide on properties and it is important for investors to learn as much as possible about these investments before taking any major risks.

In order to maximize these investments, would be investors must be able to calculate cap rates. This is the easiest place for any commercial property or rental investor to begin.

What’s A Capitalization Rate?

Also known as cap rate, this refers to the return that an investor can expect to receive from a property that they have invested in. What return does the specific asset provide in the current marketplace once the investor has paid cash?

There are a number of ways to go about the task of calculating cap rates but many of them are not as effective as we would hope. Debt terms, market factors, deferred maintenance and capital expenses all have to be considered. This makes the cap rate one of the primary tools that is going to be used.

How Is This Rate Calculated?

In order to ascertain the cap rate for a particular property, there is one simple formula to use. All an investor needs to do is divide the net operating income by the value of the property. This is the easiest way to decide on a cap rate. The formula can also be inverted, so that the investor can learn more about all of the other variables.

Net operating income divided by the cap rate provides an accurate value assessment. Meanwhile, the cap rate can also be multiplied by value to determine the net operating income.

What’s An Example of Cap Rate?

Let’s say that a seller is offering a property to an investor for $500,000 and the operating income is $25,000 per year. In order to determine cap rate, the investor would need to divide $25,000 by $500,000. The cap rate in this instance would be .05. This is the easiest way for an investor to determine what they should pay and what they could pay.

All it takes is a minor change in cap rate to significantly affect the value of a property, though. The investor must also consider the fact that there are going to be other expenses that must be deducted from the total operating income. These expenses have been known to eat up cash flow, so proceed with caution.

How To Locate a Good Cap Rate

Cap rates in modern times tend to range from four to seven percent. This is a long way from the 10 percent benchmark of old. The rates have been driven down by the influx of multifamily investors. These capital chasing deals are responsible for the brave new world that investors now live in.

As investors look to newer and more stabilized properties, cap rates will rise. It is important for investors to remember that broker cap rates estimates also tend to vary greatly from their own. The broker’s estimation is based on the amount of income that the property generates once it has already been purchased.

Investors who are looking to avoid such concerns are urged to rely on past performance as an indicator. Those who are able to make definitive changes that are immediately factored into the equation may be able to alter their estimations.

Are There Any Other Methods Of Property Analysis?

Price per unit is a typical option and it is prized for its simplicity. It is easy for investors to compare potential options when they are considering each building on a per unit basis. This method does not include any of the additional expenses associated with real estate investment. Gross rent multiplier is another common choice.

This is when the investor divides the price by the gross annual rent. This method fails to consider all expenses, too. The one percent rule is also easy enough to understand. If the units sell for $80,000 apiece, they should be rented at $800 per unit.

None of these methods are as effective as cap rate. This is why cap rate needs to become every investor’s favored marketing analysis tool. Those who are looking to maximize the return on their real estate investment will want to make sure that they are making the proper choices going forward.