Cap Rate

Investors can determine the potential income of commercial or investment real estate by calculating the cap rate. To determine the number, you must divide the property’s net income by the total purchase price. The profitability is stated in terms of an annual percentage. The ratio enables an investor to compare the income of the real estate to similar investment properties in the area. A higher cap rate property is a better investment than one with a lower rate because of the estimated returns. The cap rate plays an important role in determining the income potential of a property and the price that a prospective buyer may be willing to pay. The rate does not reflect factors that affect income, such as repairs or vacancies. It also assumes that the investor is acquiring the property without financing. If you need a loan, you must factor the interest payments into your calculation.