The expected return on investment is the most important factor in any decision in real estate investing for beginners. After all, you invest money in real estate to make more money. So it’s important to know exactly what return you should expect from your rental properties.
One of the best ways to measure return in rental property investing is through the cap rate. While some real estate exports claim that cap rate is only relevant in commercial real estate investing, many investors use it to measure the return on their residential rental properties as well. The main reason why real estate investors prefer to use cap rate rather than cash on cash return is that the former is much easier to calculate.
What is cap rate in residential real estate investing?
The cap rate, which is short for capitalization rate, is calculated by dividing the net operating income (NOI) of a rental property by the current market value (for old purchases) or the purchase price (for new purchases).
The net operating income is the difference between the rental income which you collect from tenants and the recurring rental expenses as well as vacancy losses.
To learn more about calculating cap rate, read https://bit.ly/2Z6DpXk.
However, an important disadvantage of the cap rate as a profitability metric in real estate investing is that it disregards the method of financing.
The cap rate formula does not take into consideration whether you buy an investment property in cash or with a mortgage. Nevertheless, how you finance your rental property investing business makes a huge difference for real estate investors.
But it’s this simplicity of calculating that makes the cap rate the measure of choice for many beginner investors. Moreover, it allows for an easy comparison between multiple markets and numerous real estate properties when choosing the best investment option.
What cap rate should you aim for when buying a rental property?
Most real estate experts agree that a good cap rate comes between 8% and 12%. The reason why you should not go for a very high value is that the capitalization rate also measures the risk associated with rental property investing, and you want to limit the risk, especially as a beginner.
To learn more about good cap rate in real estate, read https://bit.ly/2YrdKcM.
Wondering where to find investment properties for sale with readily available estimates of the expected cap rate?
Check out Mashvisor: https://bit.ly/317zc85.