How to Calculate Cap Rates on Rental Property: Easy Guide

If you came here googling, “how to calculate cap rate for a rental property,” you’ve come to the right place. This formula is one of the biggest tools landlords use to measure their profitability. But how does it work, exactly? In this guide, we’ll break down exactly what it is, why it matters, and how you can wield this powerful tool to evaluate your investments’ success. Let’s get into it. 

Key Takeaways  

How to find cap rate on rental property: To calculate cap rates, you look at your Net Operating Income (NOI), your total income minus any operating expenses. Then, you divide your NOI by your property’s market value, and voila: Cap Rate = NOI/Market Value. For example, if you have a $50,000 NOI and a $1,000,000 market value, the cap rate will be 5%.

Also, the higher the cap rate, the higher returns–and risk. For reference, when you calculate cap rates, a good cap rate should be in the range of 5-10%.

What is a Cap Rate? 

As experts in Austin TX property management, we know that the capitalization rate (cap rate) shows the annual return you can expect based on the property’s income and market value. It gives you a basic snapshot of this return, not including mortgage costs or other expenses. In turn, this helps landlords determine whether an investment is worthwhile. By understanding this metric, landlords can make informed decisions and ensure their investments align with their financial goals. 

How to Calculate Cap Rate on a Rental Property

To answer, “how to calculate cap rate on a rental property,” you can calculate cap rates by using a simple formula:

Cap Rate = Net Operating Income (NOI) / property’s market value

For example: With a $50,000 NOI and a $1,000,000 market value, your cap rate is 5%.

If you calculate higher cap rates, it can mean greater potential returns, but it may also come with higher risk. On the other hand, a lower cap rate typically signals more stability but smaller returns. As we’ll get into below, your ideal cap rate will look different depending on your market’s comparable properties’ values, as well as your risk tolerance. 

7 Factors That Influence Cap Rates 

Numerous factors come into play to make a property’s capitalization rate (cap rate), like:

1. Market Conditions  

As you can imagine, national and local real estate conditions have a huge impact on your cap rates. When there are high vacancies, rental rates could plummet to match. Then, that can translate to a lower cap rate. However, if the opposite happens and you can legally raise the rent, you could see your cap rate rise. For instance, if you’re in a developing market, you have the potential for bigger returns (and increased uncertainty).  

2. Property’s Condition

If your property is well-maintained and has attractive features, you likely can get higher rental (and cap) rates. To the contrary, if your property is aging or could use some fixing up, that might hurt your rental returns, and with it, your cap rate.

3. Property Type:

No property type is the same when you calculate cap rates. For example, single-family homes and multi-family ones can have wildly different investment outlooks. So, you should always be comparing your cap rate to the cap rate of comparable properties when you’re trying to get a feel for what your results could look like.

4. Operating Expenses:

The recurring costs you must make to run your property, like maintenance bills, can eat away at your net operating income (NOI). Again, this can impact your cap rate. Generally, the lower your costs, the higher your cap rate.

5. Economic Factors:

Inflation, interest rates, and other big factors can make or break your cap rate. First, these factors can adversely impact how much it costs to borrow and buy, and ultimately, how much your ROI comes up to. At that point, your worsened ROI can worsen your NOI, which then hurts your cap rate.

Maximize Your Rental Returns with BMG Texas

When you calculate cap rates, you’ve got a prime, easy way to start evaluating your profit potential. However, putting that knowledge into practice is a whole other matter. Learning how to effectively analyze market trends, manage operating expenses, and make strategic investment decisions requires years of trial and error. Unfortunately, many landlords cannot afford to make mistakes and put their bottom line at risk. 

That’s why we’ve done that hard work for you. At Bay Property Management Group, we have spent years of experience navigating the industry inside and out. We’ve learned what makes each rental market tick and thrive. Our specially trained professionals apply those lessons and best practices to the rentals we manage. On your behalf, we can do a comprehensive market analysis and help you make data-driven decisions that align with your investment goals.  Contact us today to learn more about our property management services and how we can help you maximize profitability.