The capitalization rate, often just called the cap rate, is the ratio of Net Operating Income (NOI) to property asset value. So, for example, if a property recently sold for $1,000,000 and had an NOI of $100,000, then the cap rate would be $100,000/$1,000,000, or 10%.
Calculating Cap Rate
1. Calculate the yearly gross income of the investment property. The gross income of a piece of investment property will mainly be in terms of rent rolls. …
2. Subtract the operating expenses associated with the property from the gross income. …
3. Divide the net income by the property’s purchase price.
Professionals purchasing commercial properties, for example, may buy at a 4% cap rate in high demand areas, or a 10% (or even higher) cap rate in low-demand areas. Generally, 4% to 10% per year is a reasonable range to earn for your investment property.
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