If you want to make real money in the real estate game, you need to know how to calculate cap rates.
Investopedia defines “capitalization rate” as:
the rate of a return of a real estate investment property based on the income the property is expected to generate
This is an incomplete definition, by the way.
The capitalization rate of an asset will determine:
- what you should pay on a deal;
- what to sell it for;
- how much debt you can get on the property.
Let’s go over the actual cap rate definition and how to determine it.
Real cap rates definition and formula
The real estate game will not let you down if you don’t quit.
50% of people who do a real estate deal do not do a second because the first investment was bad.
Only missing and incorrect information is what will make you get into a bad situation in real estate. This is the start of you getting all the data you need to make money in a deal.
As I said, the definition given by Investopedia isn’t entirely correct. Your cap rate is the return you are expected to make on a property if you paid cash with no debt. This tiny nuance is going to be important in making sense of the deal later on.
Now that we have that understood, here is the simple formula for calculating your cap rate:
Net Operating Income (NOI) divided by the price paid
Do the math again and again
Once you calculate the cap rate, you can use it to find missing data and see whether the information on given on the property is going to be a good fit for you.
For example, your NOI divided by your cap rate will give a good price to pay on the property. You can figure out how much a lender will give you. Most importantly, you will have a good idea of how much money this asset will cash flow you.
So, do the math on these deals again and again to “Create Wealth Investing in Real Estate“. I crunch the numbers on different deals hundreds of times on legal pads before I go forward on it.
Do your homework and real estate can pay off big for you. Calculating cap rates is the first step to getting there.
Disclosure: This content is intended to be used for educational and informational purposes only. Before investing, you should always do your own analysis based on your own financial and personal circumstances before making any investment. Grant Cardone is an industry expert who has been investing for over 30 years and his opinion is based solely on his own personal experience and circumstances. Individual results may vary. You should perform your own due diligence and seek the advice from a professional to verify any information on our website or materials that you are relying upon if you choose to make an investment. Investment involves great risk and there is no guarantee of performance or results.
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