What Are Cap Rates?

As a real estate investor, you are always looking for the next great opportunity. You may have heard about cap rates and how they can affect your bottom line, but what are cap rates and how can you use them to your advantage? On episode #71 of the Investing with GoodLife podcast, Rohan and David discuss cap rates and their numerous benefits. Read on to learn more or you can listen to the episode using the following link. Investing with GoodLife is available on all major podcast platforms.

Visit Our Podcast

Understanding Cap Rates

According to Investopedia, “a capitalization rate is used to indicate the rate of return that is expected to be generated on a real estate investment property. This measure is calculated by dividing net operating income by property asset value and is expressed as a percentage.” Basically, cap rates are a valuation metric and one of the many factors to consider when conducting a financial analysis of an investment.

As you go up the investor scale, cap rates become the most used and simple measure of how people evaluate real estate. Cap rates make it easy to compare properties regardless of the investment type and it’s usually the first thing we look at here at GLHP. Whether you’re buying a multifamily property in Dallas, or you’re buying a strip center in Orlando, it almost doesn’t matter because cap rates help categorize different investments into the same bracket.

Reasons for Using Cap Rates

Cap rates are like stock market predictions or any other formula used to look at stocks or evaluate stock speed. If the property is seen as being riskier, the cap rate will be higher in order to compensate the investor for taking on that additional risk. Additionally, If the market is doing well and investors are eager to invest in property, the cap rate will likely be lower. This is because investors are willing to pay more for a property when there is more demand for it. In essence, cap rates provide a sense of value- this is where you get your baseline number. This formula is used to make a rapid analysis of whether you should pursue an asset or pursue something else.