What is a "cap rate?"
A cap rate is a metric used in real estate to estimate the potential return on investment (ROI) of an income-generating property.
Essentially, it's a ratio of a property's net operating income (NOI) to its current market value.
Formula:
Cap Rate = Net Operating Income (NOI) / Property Value
For example:
If a property generates $100,000 in net operating income and is worth $1,000,000, the cap rate is 10%.
Key points to remember:
Variation: Cap rates vary by property type (residential, commercial, industrial), location, and market conditions.
Benchmarking: Cap rates are often used as a benchmark to compare different investment properties.
Influenced by market conditions: Cap rates fluctuate with economic changes, interest rates, and property demand
Leverage: The use of debt to finance a property can significantly impact an investor's overall return, even if the cap rate remains the same.
Reminder: While cap rates are a valuable tool for real estate analysis, they should be used in conjunction with other metrics and factors to make informed investment decisions.
