What is Cap Rate? How to Calculate Rate of Return on Property
Cap (Capitalization) Rate refers to the rate of return that a property investor can expect to generate from an investment rental property.
Not all rental properties are equally valuable investments. This is a guide for investment property owners to understand cap rate and how it is calculated in order to help them make wise investment and property management decisions.
Calculating Cap Rate: Formulas
In short, cap rate is one quick way to help estimate the profitability of a given rental property.
There are a few different ways that cap rate is commonly calculated:
Capitalization Rate = Net Operating Income / Current Market Value
Capitalization Rate = Net Operating Income / Purchase Price
The first formula is more popular among investors since calculating based on the current market value of a property is a more accurate reflection of what the property is worth right now. Plus, if a property was inherited or acquired by some other means without paying full market value for it, then the second formula would be dividing by zero.
Keep in mind that cap rate calculations do not take any open mortgages into consideration.
What is Cap Rate Used For?
Calculating cap rate will result in a percentage, which is the estimated amount for how much of the property’s value is profit.
The cap rate is an important tool for investors to determine the value of a property and whether it is a profitable investment opportunity.
A high cap rate means a higher potential return on investment, but it also suggests a higher level of risk. Conversely, a low cap rate indicates a lower potential return but lower risk as well. By using cap rate to evaluate potential investment properties, owners can make informed decisions and identify properties that are likely to yield the desired return on investment while minimizing risk.
While cap rate is not a perfect predictor of future ROI on an investment property, it helps in estimation. High cap rate indicates a higher potential ROI and low cap rate means positive ROI is less likely.
Screening Potential Real Estate Investments
Cap rate is just one piece of the puzzle in determining whether or not a potential real estate investment is right for you, according to your investment goals and strategy. If you need a new investment property to start producing a positive ROI quickly, then you’ll probably want to avoid low cap options.
What is a Good Cap Rate Percentage for Utah Investment Property?
A "good" cap rate percentage for Utah investment property depends on several factors, including the location, type, and condition of the property, as well as the prevailing market conditions.
In Utah, the average cap rate for investment properties can vary widely depending on the specific city or area. According to recent data from Mashvisor, the average cap rate for rental properties in Salt Lake City is around 5.5%, while the cap rate for properties in the Ogden-Clearfield area is around 6.2%. However, these averages may not necessarily represent what is considered a "good" cap rate for a particular property.
Ultimately, what constitutes a good cap rate for Utah investment property depends on your investment goals and risk tolerance.