This is a question that I get all of the time. What is a cap rate and how do you figure it?
First of all a cap rate is short for capitalizaton rate. A cap rate is a ratio between the cash flow produced by a property and its capital cost (the price paid for the property). The rate is actually very easy to calculate. Here is a simple example:
Annual Cash Flow (Net Operating Income)/ Property Price = Capitalization Rate
For example, if a building is purchased for $1,000,000 sales price and it produces $100,000 in positive net cash flow (NOI) then:
$100,000 (NOI)/ $1,000,000 (sales price)= 0.10 (cap rate) = 10% The property's cap rate is ten percent.
Wow! That is so interesting...now what?
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