This tutorial is based on the Omni Calculator Cap Rate Calculator tool.
Step 1: Understand the Formula
The formula for the capitalization rate (cap rate) is:
Cap Rate=(Net Operating Income (NOI)Property Value (or Purchase Price))×100\text{Cap Rate} = \left( \frac{\text{Net Operating Income (NOI)}}{\text{Property Value (or Purchase Price)}} \right) \times 100Cap Rate=(Property Value (or Purchase Price)Net Operating Income (NOI))×100
Step 2: Gather the Necessary Information
You need two main inputs:
- Net Operating Income (NOI): This is your annual rental income minus operating expenses.
- Example: Annual Rental Income = $30,000; Annual Operating Expenses = $6,000 NOI=30,000−6,000=24,000\text{NOI} = 30,000 – 6,000 = 24,000NOI=30,000−6,000=24,000
- Property Value or Purchase Price: The market value or the amount paid for the property.
- Example: Property Value = $300,000
Step 3: Plug in the Numbers
Divide the NOI by the property value and multiply by 100 to express it as a percentage.
Cap Rate=(24,000300,000)×100=8%\text{Cap Rate} = \left( \frac{24,000}{300,000} \right) \times 100 = 8\%Cap Rate=(300,00024,000)×100=8%
Step 4: Interpret the Result
The result is the percentage return you can expect annually on your investment:
- In this example, an 8% cap rate means you earn 8% of the property value annually as income.
Optional: Adjust for Additional Parameters
- Vacancy Rate: If the property isn’t rented 100% of the time, reduce income accordingly.
- Operating Expenses Percentage: Calculate expenses as a percentage of gross income for more accurate results.
Step 5: Evaluate the Cap Rate
- Compare the cap rate with similar properties or the market average to determine if it’s a good investment.
- General guideline:
- Higher Cap Rate (8-12%): Indicates higher returns but may come with more risk.
- Lower Cap Rate (4-7%): Suggests lower returns but typically less risk.
Practical Application:
Use the cap rate to:
- Evaluate the profitability of a potential purchase.
- Determine a property’s value if the cap rate and NOI are known.
Learn more: