This calculator will determine capitalization rate of your potential investment property
How to Use the Cap Rate Calculator
You need to punch in the expenses, price, and rents in order to get the cap rate.
Be careful, each cell in the spreadsheet can be edited. If you accidentally mess it up, just refresh the page.
Use this cap rate calculator to calculate:
- Capitalization rates on your rental property
- Potential cash on cash return for investment property
- Rents and expenses
- Monthly debt payments
What is a “Cap Rate?”
The capitalization rate is one method used to determine the value of income producing property. It is related to but fundamentally different than the gross rent multiplier.
The gross rent multiplier uses only the income to give a rough estimate of property and is generally used as a quick screening tool. The cap rate uses the entire picture – both income and expenses to determine property value.
It’s also important to note that the Gross Rent Multiplier and the Cap Rate are inversely related. The GRM is a price to earnings ratio while cap rate is the return on investment.
Though using cap rates to value property or your return on investment can be very accurate most of the time, it is still not applicable in some circumstances.
How to Calculate Cap Rates
Let’s take the most common application of cap rates. If you are considering purchasing an apartment building that is listed for $2,000,000 and has an NOI of $130,000, then it would be said to have a cap rate of 6.5% (or 6.5 cap).
Cap rate examples
Cap rates can also be used to back into an offer price. Let’s use the example above.
If your apartment building has an NOI of $130,000 but you know the market in your area has a 7% cap rate, you can calculate an offer price.
Here it would be $130,000 / .07 = $1,857,142.
So, you could say the market value of this property would be $1.86 million based on a 7% cap rate.
If cap rates are 6% in the market, you know the market value is closer to $2.17 million. You would have some room to bid up, or create excess equity.
Market Cap Rates Can be Tough To Estimate
One problem with cap rates is there are a lot of different rates in any one market.
Cap rates could alternatively be thought of as a risk premium. Certain buildings will be riskier than others, so they will demand a higher return to compensate the investors.
So you need a lot of data to try to break down the cap rate in each “class” of property. Once you have categorized all the other properties in the market, you can place this property into one of those classes.
You can’t expect a Class A property to have the same cap rate as a Class C property. The C property will clearly require a higher rate of return to compensate the investors for its perceived risk.
Another Way to Look at Capitalization Rates
Cap rate, along with any rate of return, can be looked at as the risk premium required to accept a given level of risk plus the risk-free rate of return.
So, if the current treasury yield is 1.6% and the cap rate for your potential property is 6%, then the risk premium is 4.4%.
Stated another way, you are being compensated an additional 4.4% to move your money from the safest investment (treasuries) and accept all the inherent risks of the investment property.
These risks could include:
- Age and condition of the property
- The type of tenants
- Market fundamentals (city/state is growing, gaining jobs, etc)
- Broader economic fundamentals (recession or growth)
When to Use Cap Rates
Cap rates are great for quickly comparing multiple properties in a given geographic area.
If one property is a 6% cap and the other is 8%, you know that one is riskier. Alternately, one may be overpriced or under-priced.
Cap rates are also good for determining market trends.
If cap rates are increasing or decreasing in a particular market, you may be able to understand the general trend. By looking at trends you may be able to decide if a certain market is over-valued or being sold at a discount relative to a long-run trend.
Cap rates can also determine when a property is being mismanaged.
If you find a property in a great location but has a high cap rate, it’s possible that the management has deferred maintenance or had low criteria for tenants. Ultimately these problems will decrease the quality and increase the risk.
It could create an opportunity for a “value add” by completing deferred maintenance and “stabilizing” the tenant base. Not only will profits increase, but you may be able to lower it’s risk premium and create value.
Cap Rate Risk Premium Example
Let’s say you identified a mismanaged C class property that would be a B- if it were managed well.
It has an NOI of $100,000 and is selling at a 7% cap rate for $1.43 million.
Now let’s say you put $100,000 of work into the property and raise the NOI to $110,000. At a 7% cap rate, the new value is $1.57 million. Not bad, you created about $40,000 in equity.
But, what if by doing the upgrades and making the tenant base higher quality, you have reduced the risk of the property from a C to a B-. In this imaginary market, let’s say a B- is going for a 6.7% cap rate.
You are now rewarded with a property that is worth $110,000 / .067 = $1.64 million.
You’ve created $40,000 in value through renovations then an additional $70,000 by reducing the risk for a grand total of $110,000 in equity.
When You Shouldn’t Use Capitalization Rates
If the property has a complex income stream that is irregular or will have large variations in cash flow it can be hard to estimate your rate of return. In these situations, it is better to use a discounted cash flow analysis.
For example, you may purchase a property and plan multiple phases of major renovations over a 3 year period. The renovations may cause high vacancy rates sporadically and create different rental rates at different points of time.
This sort of analysis is beyond the scope of cap rates and you would need something more advanced.
Cap rates also aren’t good at calculating the value of certain types of buildings with unique purposes. An example would be a large or historical structure such as a church or cathedral. These sorts of buildings would be valued using a cost approach.
Cap rates are also terrible at valuing properties that may be owner-occupied. These tend to be 1-4 unit residential properties but can include small mixed-use buildings.
4 units is not a strict cut-off, and buildings with slightly more may use a hybrid approach.
I general, a small residential property would be valued with the sales comparison approach, which can be estimated with a comparative market analysis.
Rental and Commercial Property Valuation is Complicated
There is no exact answer to evaluating the value of any property. Everyone has a different risk tolerance and ROI goals. What may be a good deal to one person may be a terrible deal to another person.
These methods should be used to help you analyze if the deal is good for you. It can’t be used to judge if the deal is good for someone else.
You need to be armed with knowledge about every aspect of property valuation and return calculations in order to get what you want out of your investments.
What is a Good Cap Rate?
Well, that depends…
Deals With High Capitalization Rates Often Have Significant Problems
When the going cap rate for a specific class of real estate is 8% and you find a deal at 15%, you have to wonder why.
It’s because no one will buy it at an 8 cap! It might be in a bad area, have a litany of problems, or have major structural issues.
The other major concern – when it comes time to sell, will you be able to get the same or lower cap rate, or will it be higher?
If you’re buying at a 15 cap, you’re very unlikely to sell it at a 8 cap. It’s just probably not going to happen.
Let’s say the city your in has C-class property trading around an 8% capitalization rate and you find a sweet deal at a 12 cap! It’s fully occupied, fully stabilized, needs almost no work, and they will trade it for a ridiculous 12 cap. Sounds like a steal, right?
I recently looked at a deal very similar to this. I got there and discovered a lot of very serious deferred maintenance – roof, siding, etc. Also, it had some structural issues that needed to be repaired. So, though the property was fully stabilized, the amount of work required is why it was trading at such a high cap rate.
And, even if you could turn around and sell it at an 8% cap rate, the deal still wouldn’t have made any money.
So, high cap rates don’t mean good deals.
Deals With Low Cap Rates Aren’t Always Desirable
On the other side of things, low caps don’t always signal a safe and desirable deal.
Sometimes a deal has a low cap rate because it’s significantly underperforming. Deals with a ton of upside potential will sell for a very low cap rate compared to other properties that are performing properly.
Let’s say a C-class property is generally trading around a 7 cap in your area. So, a deal with an NOI of $100,000 would sell for around $1.4m.
Let’s take another deal that has been severely mismanaged and is half vacant. It’s structurally OK, needs some minor repairs, but really just needs some new management and new policies. It’s NOI is only $10,000 (if it’s lucky), and more often than not it’s losing money.
Would you expect this apartment building to sell for $140,000?
Of course not.
Realistically, the cap rate would be pretty close to zero because of how low the NOI is in this example.
I used this as an extreme example, but the point is to illustrate that low cap rates don’t always mean bad deals with low cash-flow.
What is a Good Cap Rate?
Getting back to the question at hand – what is a considered a good cap rate?
If your goal is to buy a full stabilized asset, you should look for something that is trading for about what is average in your area.
Instead, If you are looking for a deal where you can potentially add value, consider looking at deals that are trading at a LOWER cap rate.
If you want deals in problem areas with high potential cash-flow, but aren’t focused on the value-add, then consider deals with high cap rates.