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WTF is a Cap Rate?
Yeah, the house looks great. And the price seems fair. But will it make any money? Will it make enough money to justify the expense of buying it? How do you know?
One method to estimate the profitability of an investment property is to calculate the Capitalization Rate — Cap Rate. This will provide you with the profit margin on the investment — or rate of return.
The first step in calculating the cap rate is to determine the value of the property. On a purchase, this can be the purchase price, or the estimated renovated value if you plan to do some work before renting it.
Let’s use the property from the WTF is BRRRR post.
The purchase price of the house is $160,000. The renovations will cost $25,000. The renovated value of the home, as estimated by similar properties for sale in the area, is $220,000. We’ll put the value of the property at $220,000.
Next, let’s figure out the Net Operating Income or NOI. This is the figure I find the most important when evaluating a rental property. How much money I’m going to make is a driver for me.
Since we are buying this house, and doing some updating, we’ll have to estimate the rental income. From what I could see, the projected rent is $1750 per month or $21,000 per year. This is the gross rental income.
