The capitalization rate, or cap rate for short, is the clampdown used to calculate the real estate return rate. It is usually considered in real estate investments of commercial value, such as office buildings, hotels, or warehouses. From time to time, it is also calculated in residential buildings. So how is the cap rate calculated, what are the factors that affect the cap rate, and at what rate does the cap rate earn its investors?
How is Cap Rate Calculated?
To calculate the cap rate in the most basic way, you need to divide the net operating income of the property you own by the market value of the property. Net operating income is obtained by subtracting management and operating costs from the generated income. If your property is mortgaged, the costs of mortgage payments are also considered. Any capital expenditure or depreciation deductions are not included in net operating income. However, the cap rate is not a calculation that works entirely accurately. It can also be said that there is not as much certainty as to the stock market.
Factors Affecting Cap Ratio
The main factors influencing the cap rate are the type, location, interest rates, and expenses of the investment.
1) Type of investment: There are many different types of real estate for investment property. Therefore, the cap ratio of all of them may not be equal. For example, a warehouse or a retail building may have a high cap ratio, but it poses a serious risk in the economic recession.
2) Location: Urban areas vary more in cap ratio compared to rural areas. Where there are more local and similar economic conditions, the cap rate is lower.
3) Interest rates: Rising interest rates reduce the value of your property and there is an increase in borrowing. Increasing your debt will result in a decrease in your net income and therefore the cap rate.
4) Expenses: Insurance fees and other risks may cause a decrease in the cap rate as they will increase your expenses, so it may be necessary to reduce the risks.
What is the Good Cap Ratio for Investment Purposes?
There is a linear relationship between the cap ratio and the risk level. The higher the cap rate for an investment, the higher the risk. When calculating the cap rate for rental investments, you should also consider the risk level. In fact, the level of risk in all types of investments can help you determine whether the investment makes sense. According to real estate experts, a cap rate between four percent and ten percent is a good one. However, if you invest only by looking at the cap ratio, you can also lose money.