We’ll look at cap rates, how you calculate them, and their significance.
Today I’ll answer the questions: What is a cap rate? How do you calculate it and what exactly does it mean? These are questions that I get asked daily and, surprisingly, it’s not just from new investors. I also get these questions from seasoned and experienced investors that own and manage multiple properties.
What is a cap rate? The cap rate is your return on investment without having a mortgage payment. It’s your return on investment, assuming you bought the property all cash. For example, if you purchased a $1 million investment property using all cash, the property generated $100,000 in gross rent roll, and your operating expenses were $50,000, that means you have a profit of $50,000. If that’s your return and your investment was $1 million, you’d have a 5% cap rate on that property.
Think of it as less risk, less reward and high risk, high reward.
Every city, town, and neighborhood in America has different cap rate ranges. Your A and B markets, which are your most desirable markets, typically have a range of about 1% to 3% for a cap rate. Your C and D markets, which are your less desirable neighborhoods and markets, typically have a higher cap rate of around 7% to 10%.
Think of it as less risk, less reward and high risk, high reward. Typically the higher the cap rate, the less chance for appreciation in the long term then vice versa. When you have a lower cap rate, that means you’re going to have a higher chance for appreciation down the road. Additionally, try thinking of it as a spectrum. On one end you have your A and B markets that have low cap rates but high appreciation, and on the other end, you have your C and D markets with higher cap rates but lower appreciation.
If you have questions about cap rates or anything related to investing in multi-family properties, please feel free to reach out. Contact me at the information below. Have a great day.
CEO, Multi-Family Property Exchange, LLC 1-888-48-MULTI
Realtor, LUX realty North Shore 978-922-1000