What is a Cap Rate?

What is a good cap rate for a Vancouver rental property?

What is Cap Rate?

The cap rate focuses on Return on Investment (ROI), assessing the rental income from income properties, their prices, and their operating and rental expenses to provide an accurate measure of a property's profitability. ROI can be evaluated using two methods: cash on cash return and the cap rate.

Cap rate, or capitalization rate, is an ROI metric for rental properties, independent of financing methods. It considers the rental income, expenses, and property value, indicating the profit investors gain from the property's value, always shown as a percentage. The cap rate is crucial for generating income in real estate, regardless of the rental strategy.

How to Calculate the Cap Rate?

The cap rate is determined using the net operating incomes and recent sales prices of similar properties. First, obtain the recent sales price of a comparable income property, then calculate its net operating income, and finally subtract all operating expenses except the mortgage. Here's an example to assist with the cap rate calculation formula:

What Affects a Good Cap Rate?

As with most properties, location still impacts the value of what you’re selling, renting, or buying; this is why the rental strategy can change the range of what is a good cap rate. For instance, Airbnb rentals tend to generate higher rent compared to traditional rentals, while these, on average, cost less in the rental expenses. Cases like these can make the range of a reasonable cap rate differ depending on the rental strategy. Another factor that’s involved in the outcome of a good cap rate is the property type, which means that multifamily rentals can have higher cap rate than single-family homes; also, ranges can vary from long-term to short-term rental properties.

Why is Cap Rate so Important?

The three main reasons are the return on investment, the comparing of investment properties, and the estimated payback period. The cap rate is one of the forms of return on investment (ROI), as real estate investors need to determine how profitable the income of your property is.

Comparing investment properties is essential to distinguish between investment properties based on expected profitability. Finally, the estimated payback period is needed so you can know if the cap rate will fully cover the property payment. How do you estimate the payback period? You only have to divide 100 by the cap rate of the property; for example, if the payback period of the property is 12 years, the formula is 100 divided by 12.

The world of real estate is a bit confusing, but once you start going deeper into concepts, there may be a chance you can have it all under control. In case all this still turns your head into a mess, don’t hesitate to call me to help you manage your property or guide you through the process regarding any type of property.