Real Estate Capitalization Rate Calculator

Operating income, or income you get from running the property, is included in the cap rate formula. Sources include:

• Rental income
• Parking structures
• Vending machines
• Laundry service
• Other amenities

Operational expenses and maintenance costs are included in the cap rate formula. Examples of expenses include:

• Building maintenance
• Property Management
• Property Tax
• Utilities
• Insurance

Capital expenditures that are long-term investments for the building do not count as operational or maintenance expenses and are not included in the cap rate formula. Instead, they affect the adjusted cost basis of the property.

The range of cap rates will differ across different property types, time periods, economic conditions, locations, and many other factors that play a role in determining the price or risk of a property.

What is a good cap rate?

A good range for cap rates is between 4% and 12% depending on the area and property type. You can find a more accurate range by researching cap rates for properties similar to yours in the same area. If the cap rate of your property is below that of similar properties, it might be overvalue. If the cap rate is above that of similar properties, the property might be undervalued. Either case is not necessarily good or bad, but they mean that you need to do more research on why the property is being valued the way it is.

Ultimately, a good cap rate for your personal investment will have a wide range depending on your investing strategy, area of purchase, and many other factors. At minimum, your cap rate should be greater than your cost of financing: for example, if you have a 5% mortgage then a property with a cap rate below or equal to 5% is expected to be a money-losing investment.

No. Any expenses related to debt, including the rental property mortgage and interest payments, are not included because the calculation focuses on only the property and not the financing involved in obtaining it. This is the advantage of using cap rates as it does not distract you with debt and assumes using cash, which allows you to focus on the worth of the property without considering complications of accounting for different financing methods that people use.

Property taxes are included in the cap rate calculation, but income taxes are not. This is because income tax rates will differ between owners and situations but property taxes will stay the same.

The main difference between cap rate and yield is that cap rate is a valuation based on current income at current prices whereas yield is based on current income vs your initial investment. Cap rate can change from year to year depending on the valuation of the property while your yield will generally stay the same unless your income significantly changes.

There is an additional type of yield called a levered yield. A levered yield takes into account your costs in financing the property (e.g. mortgage interest costs) and compares the income from the property to your down payment or equity rather than the total cost of the property. This helps you understand how profitable a property is in a more practical context.

For example, let’s say that after financing costs your yield on a $1M property is only 1%, or $10,000. This might seem like a bad investment, but if you only had to put down a down payment of 5%, or $50,000, your levered yield would be 20% a year ($10K/$50K *100%).

The levered yield also helps you consider if a property is unprofitable. For example, a property can have a yield of 4% and seem profitable, but if you have to borrow at 5%, your levered yield would be negative and reflect the fact that you will be losing money on the property.

Return on Investment (ROI) is a measurement of your income from the property compared with its cost. It adds financing costs such as mortgage interest to the cap rate calculation. Accordingly, ROI can vary drastically from buyer to buyer since different buyers will use different financing methods; ROI is more focused on how the investment will affect the individual investor while cap rate is more focused on the property itself.

Cap rate is a quick and convenient calculation to measure how the market values a specific property relative to other similar properties in the area. However, it's only applicable to income-generating properties and can be misleading for properties whose valuations are driven by factors not associated with income potential such as single-family residential homes. The cap rate may not be useful to you if you are simply buying a home to live in without the intent to generate income for it or if you are only focusing on price appreciation potential.

Pros of using the cap rate:

• It is a way to quickly compare similar properties
• It is a commonly used measurement
• It can give you insight as to how the market views a certain property
• It can point out potentially undervalued or overvalued properties

Cons of using the cap rate:

• It does not take into account financing costs which can significantly impact the profitability of a property
• It does not take into account possible leverage used when buying a property and can understate a property’s profitability
• It will fluctuate based on the valuation of the property
• It is only useful for income-generating properties like rental homes and offices and not properties valued on other characteristics like potential price appreciation

Cap rate is best used as a way to measure the valuation of a property. It allows you to easily compare different properties of the same type without having to consider the complexities of financing. It can point out possibly undervalued or overvalued properties and tell you how the market views a certain property, especially in terms of its risk.

Cap rate is not the best way to measure the potential profitability of a property, however. The levered yield or ROI of a property would be better ways to check a good or bad investment. These take into account your financing costs and better reflect the financial return of a property compared to your investment or down payment.