Using The Cap Rate in Real Estate Investing

The numbers in real estate are critical to understand BEFORE investing in a rental property. It is highly recommended to do your own calculations because everyone looks at a property’s potential through a different lens.

When investors are analyzing a deal they use rental data and expense estimations to come up with the numbers they will use in their calculations. Investors will use projections for rents, property management fees, maintenance costs, and taxes to calculate the NOI and cap rate of the property.

What is a Cap Rate?

A “cap rate” or capitalization rate is used by investors to determine the annual return on their investment. To find the cap rate, divide the net operating income (NOI) by the purchase price of the property and multiply by 100 Cap Rate= NOI / Purchase Price X 100%. Cap rates will vary depending on location, and I recommend talking with a local investor or property manager in the area of your potential investment to determine if the property makes sense financially.

What is a Net Operating Income (NOI)?

A “NOI” or net operating income is calculated by subtracting all expenses from the gross income generated from the property, and can be calculated on an annual, monthly, weekly, or daily basis. Most commonly, this number is calculated on a monthly or annual basis.

NOI Example: To calculate the annual NOI. Taxes= $6000, Insurance= $1500, Property Management Service= $2400, Maintenance= $500 and Annual Gross Income= $52,800

NOI= $52,800 - $6000 - $1500 - $2400 - $500= $42,400

Cap Rate Example: An investor in Portland, OR wants to buy a multi-family property with four units. The property is listed for $650,000, annual taxes are $6000, insurance is $1500, and property management fees are $2400. The property has four units that rent for $1100 per month, which equals $52,800 annually ($1100 X 4 units X 12 months). First find the annual NOI, $52,800- 6000-1500-2400= $42,9000. Then, divide NOI by purchase price $42,900 / $650,000= .066. Last, multiply by 100% to get the cap rate, .066 X 100%= 6.6%. In Portland, OR this would be considered a good deal.

Trent J. Werner

(971) 235-1312

REALTOR®

Licensed Oregon Real Estate Broker