How To Calculate Cap Rate: Calculator, Formula, & FAQsJan 30, 2024
The capitalization rate helps determine whether or not a deal’s rate of return and potential profitability is worth the initial investment; it is quite literally a calculation that attempts to tell investors if they should invest in a particular opportunity.
Trust us--there are plenty of options property investors will want to analyze with an easy-to-use cap rate calculator.
That said, nobody will teach you how to calculate the cap rate for real estate if you don’t ask; you need to be proactive and translate the information you come up with into actionable steps.
Instead of relying on others, we’ve developed a free cap rate calculator for our readers to use!
Along with our calculator, this guide will tell you everything you need to know about cap rates, including:
- Use Our Free Cap Rate Calculator
- What Is Cap Rate?
- How Does A Cap Rate Calculator Work?
- The Role Of Cap Rate In Investment Properties
- What Is The Cap Rate Formula?
- How To Calculate The Cap Rate
- Cap Rate Formula Examples
- Impact of Net Income on Property Value
- What Is A Good Cap Rate?
- Limitations Of Capitalization Rate
- Capitalization Rate: Frequently Asked Questions
- Final Thoughts On Cap Rate Calculators
Cap Rate Calculator
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What Is Cap Rate?
The capitalization rate, or cap rate, is an invaluable metric that can help quantify the expected rate of return on commercial investment properties (not unlike apartment buildings). As a result, the real estate investing community has come to rely on cap rates to analyze deals and compare potential returns before following through with a purchase.
On the surface, cap rate is one of the best ways for real estate investors to determine whether or not a deal is worth pursuing. A properly calculated cap rate can estimate a property’s rate of return.
However, a cap rate should only complement a comprehensive and detailed analysis of the subject property; it’s not designed to stand alone.
If for nothing else, the cap rate is an approximation, not a definitive value. Nevertheless, despite their inherent inefficiencies, cap rates are an invaluable tool for an experienced investor.
How Does A Cap Rate Calculator Work?
A cap rate calculator is used to measure a subject property's expected rate of return.
As its name suggests, a cap rate calculator will help turn relative variables into quantifiable values expressed as a percentage. The percentage resulting from the calculation will give investors an estimated return on investment (ROI).
Try out our free cap rate calculator above to get a close estimation of your ROI.
Why Use A Cap Rate Calculator?
In today's digital era, cap rate calculators have become indispensable tools for investors. These online calculators simplify the process of determining the cap rate, ensuring accuracy and saving time. Whether you're a seasoned investor or a novice, understanding and utilizing a cap rate calculator is essential for making sound investment decisions.
Read Also: How To Calculate ROI On Rental Property
The Role Of Cap Rate In Investment Properties
Cap rate is more than just a number; it's a guiding metric that shapes your investment strategies. A higher cap rate often indicates a potentially higher return but comes with increased risk.
Conversely, a lower cap rate might suggest a safer investment but with lower returns. By using our cap rate calculator, investors can align their strategies with their risk tolerance and return expectations.
What Are Capitalization Rates Used For?
Cap rates are most commonly used for estimating the returns on investment properties. Upon a closer look, however, the metric is more versatile than most people give it credit for. In addition to estimating returns, cap rates may be used in the following ways:
- Reverse Engineer Valuations: Investors may calculate the cap rate if they have the NOI and the value of the property. However, what if the market value isn’t available? If investors can access the cap rate and the NOI, they can estimate a property’s valuation with a similar calculation (NOI/cap rate = property value estimate).
- Compare Similar Properties: If investors are torn between similar investments, the cap rate can help determine which of the real estate comps to choose. Pitting two properties’ cap rates against each other will reveal which investment will likely produce more returns relative to its purchase price.
- Assess Risk: Calculating cap rate metrics can give investors a better idea of the risk associated with the property. All else being equal, a property that returns less capital relative to its purchase price is riskier than a property that returns more. Therefore, comparing the cap rates of two similar subject properties can tell investors which represents the more significant risk.
- Loan Approvals: If lenders know the subject property being purchased is for investment purposes, they may use the cap rate to evaluate a borrower’s risk profile. Anything a lender can use to assess the risk of a loan will ultimately change the underwriting, which can impact the terms of the impending loan.