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Updated over 6 years ago on . Most recent reply

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Derek Morrison
  • Rental Property Investor
  • Marshfield, MA
28
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89
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Cap rate: which is better?

Derek Morrison
  • Rental Property Investor
  • Marshfield, MA
Posted

All other things being equal, is it better to have a higher cap rate than a lower one? Is a 10% cap better than a 5%? And why?

  • Derek Morrison
  • Most Popular Reply

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    567
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    Oleg Shalumov
    • Rental Property Investor
    • Teaneck, NJ
    291
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    567
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    Oleg Shalumov
    • Rental Property Investor
    • Teaneck, NJ
    Replied

    @Derek Morrison higher cap is better when you are buying, as it means that comparing to the price you are paying the property would produce more cash flow to the owner. 

    When you are selling it is better to sell at the low cap. It would mean that you are getting more money for the property you are selling.

    The formula for the cape Rate is the following: 

     Cap Rate = Net Operating Income / Price

    Net Operating Income (NOI) is the sum of all potential income less vacancy and operating expenses. NOI does not consider debt payments, depreciation, or capital improvements.

    Here is a very basic example:

    You are buying a 10-unit apartment building which is offered for sale at $1 million. Its annualized rent roll is $100,000 with operating expenses totaling $40,000. What’s the Cap Rate ?

    Capitalization Rate = ($100,000 – $40,000) / $1,000,000 = 5.5% Cap

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