A cap rate, otherwise known as a capitalization rate, is nothing short of one of the most important fundamental indicators for determining whether or not a property is worth pursuing. Not surprisingly, cap rates have proven instrumental in building some of today’s most prolific real estate investment portfolios, and there’s no reason it couldn’t help you do the same. In fact, I’d argue that you can’t even build a halfway decent portfolio without identifying the cap rate of each and every one of your assets; it’s that important. Therefore, it’s in your best interest to not only gain a better understanding of what a cap rate is, but also how to use it to strengthen your investing efforts.
What Is A Cap Rate?
A cap rate is one of the easiest and most dependable ways to quantify whether or not an investment deal is worth following through with. In its simplest form, however, a cap rate is nothing more than an equation; one that’ll identify how much an investor stands to make (or lose) if they end up buying the property in question. It is worth noting, however, that a cap rate won’t provide investors with the exact amount they stand to gain, but rather an estimate. Cap rates are no more accurate than stock market predictions; they are subject to an inherent degree of error, and should, therefore, be “taken with a grain of salt.” I repeat, cap rates are not 100% accurate; they are merely used to estimate one’s potential return on his or her investment. That said, a properly estimated cap rate is invaluable when supported with due diligence and an acute attention to detail.
Cap rates are not intended to act alone; they are but one piece of the puzzle. A cap rate by itself is almost useless, but a cap rate with supplemental data and information can significantly mitigate the amount of risk an investor will be exposed to over the course of an investment. And therein lies the benefit of learning how to calculate cap rate: the resulting number can mitigate more risk than many investors realize. If you know how much an investment could potentially make, it stands to reason you’ll know whether or not you should pull the trigger on the purchase.
– Good Cap Rate For Your Investment Property