Cap rate or capitalisation rate
What is it?
The cap rate is a common metric in real estate investing that helps estimate the potential return of a property. It stands for “capitalization rate,” and it tells you what percentage of the property’s value you’d earn annually from its net income.
Investors use it all the time to compare how profitable different properties might be. It’s super straightforward to calculate: just divide the property’s Net Operating Income (NOI) by its market value (or purchase price), and multiply by 100 to get a percentage. Here’s the basic formula:
Cap rate = (Net Operating Income / Market Value) × 100
For example, if a property brings in €50,000 a year in net income and is worth €1,000,000, the cap rate would be 5%.
Key aspects to consider
The cap rate is a key indicator in investment decision-making, but it should not be considered in isolation. Factors such as the location of the property, the state of the real estate market, and the risks associated with the asset must also be evaluated.
In general:
A high cap rate = higher potential returns, but possibly higher risk.
A low cap rate = lower risk, often in more stable or high-demand markets.
Investors use cap rate as a reference to spot opportunities, compare properties, and analyze real estate market trends. Having a solid understanding of how this metric works is key for anyone looking to fine-tune their real estate investment strategy.