You will need to compare the cap rates on similar potential investments properties. Compare the cap rates for similar properties, such as duplexes that are located in the same central area. This will help you to decide which property is best for you.
Knowing the cap-rate of potential investments will help you decide whether the asking price is reasonable. If it's too expensive based upon your cap-rate calculations, you might still be able to negotiate for a lower cost.
The cap rate you desire when purchasing an investment property is important. Higher cap rates are better for your annual return. The cap rate should determine whether you plan to make at least a specific percentage of your investment income each year. To determine the price for a particular property, you can divide your calculated net profit figure by your target cap rate.
Most real estate investors account for a 5--10% loss of rental income in their calculations. Consider the following scenario:
Also, the caprate is calculated under the assumption that you will pay all cash for the property and do not need to take out any loans. It doesn't account for any mortgage-related costs such as points or interest. It also does not account for other costs like closing costs and brokerage fees.
Calculating the cap rates of properties is not very useful if you intend to flip them, make it a vacation rental, or rent out the property for a short term. It is important to retain a property you have flipped for as little as possible. If you rent short-term vacation homes or short-term rentals, it is likely that there will be swings in income or occupancy. Also, operating expenses can fluctuate due the seasonal maintenance and repairs required by high tenant turnover. These factors will affect your net income and result in a less reliable cap rate calculation.
When you are evaluating property that is expected to provide regular, predictable income, you can use the cap rate as a useful metric. In this example, the cap rate would be calculated for a 4-unit apartment built occupied with tenants on long-term leases.
