You need to understand financial concepts to make informed residential real property investments. There are many factors that go into evaluating potential properties. Unfortunately, there's no one-size fits all method that you can use when deciding if an investment makes sense for you. However, learning how and when to use valuation tools will equip you with the knowledge to pinpoint the best method for each prospect.
Net operating revenue: Your gross rent income (the money you earn from renting) less any operating expenses (such a payroll and repair costs. These are the steps to get this number.
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:
An estimate of annual operating expenses is $5,800. Property taxes are $3,800. Maintenance and other expenses are $2,000.
As can be seen, there are many factors that could impact the cap-rate for a particular asset at any moment. The best way to decide if a cap rate is good is to review the asset against other comparable assets, compare it with sales at the time of purchase, review the cost of capital, and assess the risk tolerance and risk profile of the investor. There are lots of publicly available data to determine whether a cap rate on a particular asset matches the risk/return of similar assets. After performing proper diligence and accounting the variations in the comp set for potential risks, an individual can determine exactly what a "good” cap rate is.
There are many ways of calculating the cap rate. However, we will only be focusing on the most common. The basic formula for calculating the cap rate is:
Capitalization rate, also called "caprate", is one common indicator of a property’s potential to be an investment. The cap rate represents the potential annual rate to return, or loss or gain on your investment.