It looks at general operational expenses and vacancy rates, meaning it’s a more accurate way to see if a rental property’s viable. To figure out the cap rate, you divide the NOI by the current market value. You then multiply that by 100 to get a percentage.
Cap Rate: (net operating income / market value) x 100
Of course, you’ll need to do your research to determine market value and operating income. Investors often analyze cap rates of similar properties to figure out what rate they need. Sometimes, investors have the cap rate already. In that case, they can use it to figure out the market value of the property:
Market Value (Using Cap Rate) net operating income / cap rate = market value
As I mentioned, cap rate is the most accurate — and therefore preferable — way to figure out whether to purchase a rental property. That’s why it’s the method that’s used most frequently by anyone in the real estate business, including appraisers and banks. However, it can be tricky to determine the cap rate for a property that’s already sold because you don’t know what the operating costs are. Unlike with GRM, there’s no ideal range for cap rates. They vary from market to market to the extent that in city A, anything below 6% should be passed on, whereas in city B, a 4% cap rate is something to jump on.
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