The "cap rate" or capitalization rate of a property is what I call an an "investment measure." It is a value that compares the income generated with the acquisition cost of an investment.
For example, if you purchase an investment property for $160,000 and it generates a net income of $16,000, then the cap rate for the property is 10%.
To take it a bit further, let's look at this example of a Beacon Hill townhome as an investment property:
Purchase Price: $160,700
Gross Operating Income: $10,476
($900/month - 3% vacancy)
Operating Expenses: $1,479
($949 taxes + $405 insurance + $125 POA dues)
Net Operating Income: $8,997
($10,476 gross operating income - $1,479 operating expenses)
Capitalization Rate: 5.6%
($8,997 net operating income / $160,700 purchase price)
A few other notes about cap rates:
- The cap rate is independent of financing. It is not a measure of whether an investment property is a "good opportunity" when your particular financing scenario is included.
- Your analysis of operating expenses sometimes would also include management costs, repairs, utilities and advertising
- The cap rate of a particular property can be helpful, but even more helpful is comparing the cap rate of several properties that you might purchase.
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