One of our newer forum members recently asked:
“What’s the difference between ROI and CAP Rate?”
Thanks to one of our resident experts, Ryan Webber, he got a perfect answer:
ROI is your return on investment factoring in your financing. Its your annual cash flow after all expenses divided by your initial investment (out of pocket expense). ROI depicts the true percentage that you will make on your money in the first year. Capitalization rate (cap rate) is your ROI if you paid cash for the property. It doesn’t include financing. It is a better way to compare apples to apples and take financing differences out of the picture. Cap rate is factored by taking your annual Net Operating Income (NOI), which is your gross income minus all expenses except debt service (principal and interest mortgage payment), and dividing that by the purchase price of the house.
Again, Cap Rate is the percentage you would make on your money if you paid cash for the property, and ROI is what your actual percentage is when you factor financing into it.
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Article Author: Joshua DorkinJoshua has written 570 articles for us.
Visit Joshua's Website: http://www.biggerpockets.com/
Joshua Dorkin (@jrdorkin) is the founder and CEO of BiggerPockets.Mr. Dorkin's vision for BiggerPockets has helped to propel it into becoming one of the top real estate destinations online. His vision for the site and its future has brought national press attention to both Mr. Dorkin and to BiggerPockets.
Joshua Dorkin
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Great Post. Next up: Discounted Cash Flows. Cap rates are a must know before you start to value a property using the discounted cash flows method. Great explanation though on the ROI vs. Cap Rate question.
Glad you found the post helpful, Garrett!
Great stuff josh
Good info. Love blogs where I can learn something new!
Why would you ever use CAP over ROI?
When I see a property, I want to know all of the expenses compared to profits so I can get a realistic expectation of what will happen to my investment.
CAP rates seem like they are better for those trying to sell a property.
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