A real estate investor uses a capitalization rate, or cap rate, to determine the maximum amount he/she should spend given the annual return that he/she plans to make. The cap rate allows investors to compare properties across the board even though those properties may have varying net income and purchase prices. Below are simple steps to calculate a cap rate.
1. Calculate the net income of the investment property.
- The gross income will usually include rent rolls, although misc. income may also accrue from the property such as income through vending machines.
2. Calculate expenses associated with the property.
- This includes operating expenses only. The cap rate does not account for all of the property’s business expenses, such as purchase costs of the property (mortgage payments or fees). These expenses reflect the investor’s standing with the lender and are variable in nature.
3. Calculate the cap rate.
- Cap Rate = annual net operating income / cost (or value).
EXAMPLE: An investor purchases a townhome for $30,000. It is currently rented for $600 per month ($7,200 per year). There is a 10% property management fee, $600 in taxes, $500 for insurance, and account for 5% for maintenance.
- $7,200 (gross income)
- -$720 (property management)
- -$600 (taxes)
- -$500 (insurance)
- -$360 (maintenance)
- =$5,020 (net income) / $30,000 (purchase price) = $16.73% cap rate
Contact Lee Anna Pham for any interest in investment and income properties in the Hillsborough and Pinellas Counties to include Tampa, Lutz, Brandon, St. Petersburg, Clearwater, and Pinellas Park, Florida.
