A cap rate is simply a formula. It’s the ratio of a rental property’s net operating income to its purchase price (including any upfront repairs): Cap Rate = Net Operating Income (NOI) ÷ Purchase Price
As an investor, you have to protect yourself against the possibility of losing money.
A higher cap rate means an investment is more risky. A lower cap rate means an investment is less risky.
There are 3 major factors that affect cap rate: 1. Macro-level economics and demographics 2. Micro-level market influences 3. The type of property
1. Pick a market, submarket, or property type to invest in 2. Set goals and perform analysis for property acquisitions 3. Decide to sell an existing property
And good decisions lead to you accomplishing your overall real estate and financial goals.
With investment decisions, there are no clear-cut answers. A “good” cap rate will depend on your personal investment criteria and preferences.
Cap rates are important, but they’re one of many criteria you should use to evaluate a purchase. You can also read my article How to Run the Numbers – Back of the Envelope Analysis for a more comprehensive look at my approach to property analysis.