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.
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.
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.
An estimate of annual operating expenses is $5,800. Property taxes are $3,800. Maintenance and other expenses are $2,000.
The above calculation assumes that all rent is paid each month. It also assumes that the property remains occupied at 100% throughout the year. If you have a single-family house, it is more likely that 100% occupancy will occur regularly. However, this is unlikely for multi-unit buildings. Your cap rate should be calculated to reflect a lesser than 100% occupancy rate whenever possible. Here's how:
Most real estate investors account for a 5--10% loss of rental income in their calculations. Consider the following scenario:
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.
