Harrison Loke of Finandom recently reviewed an article by Otesa Middleton Miles on the Bankrate.com web site, which looked at the math that real estate investors should do when making investment decisions. The math behind determining a property's capitalization rate caught our eye and has inspired our latest tool!
The capitalization rate for a real estate investment property is the ratio of annual net rental income received for the property divided by its purchase price, which is expressed as a percentage. It's useful in that it allows an investor to compare potential real estate investments by property values independently of how the financing for the properties being considered would be structured (amount of down payment, interest rates, closing costs, etc.)
Here's the data you'll need to use the tool:
- Annual rental income.
- Annual operating expenses (not including mortgage payments.)
- The property's purchase price.
And that's all! Here's the tool:
How To Use the Capitalization Rate as an Investor
The article quotes real estate investor Doug Crowe for how an investor would use this information:
If you're selling a property, says Crowe, "It's better to have a buyer willing to accept a lower cap rate. But if I'm buying, I want a high cap rate." For instance, if you buy a property with a cap rate of 8 percent and did nothing to it but raise the price, the cap rate drops to 7 percent. You've made a profit.
The article notes that capitalization rates of 7-8% are common in the midwest region of the U.S., while 6% is common on the coasts.
Previously on Political Calculations
- Investing in Real Estate for Cash Flow - our tool for calculating cash-on-cash return!
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