Are you planning on investing in rental properties in Monterey County, or elsewhere in the United States?

If this investment property will be your first, you’re going to want to know what is a good capitalization rate (cap rate) for your investment.

In this article we will break down cap rates in real estate investment and provide you information for information on how to choose the best investment with a great cap rate.

What Is A Capitalization Rate?

Before we get started breaking down Capitalization rates, let’s explain exactly what a Cap Rate is, it’s an indicator of market sentiment.

Cap rate is also the ratio between the net income of the property and its original price or capital cost. Cap rate is expressed as a percentage.

Understanding Cap Rates

For those who are familiar with finance but new to real estate, think of a cap rate as the reverse of the price-earnings ratio (“P/E”) used in the stock market. While the P/E ratio measures the price, or market value, of a stock divided by its earnings per share, the cap rate measures the annual income of a property, divided by its cost, or value.

Cap rate formula

What does the cap rate tell us?

Put simply, cap rate measures a property’s yield in a one-year time frame. This makes it easy to compare one property’s cash flow to another – without taking into account any debt on the asset. In short, it provides the property’s natural, unlevered rate of return.

Another way to think about it as a measure of risk in the deal. What return would you expect given the risk of the specific property or asset? Everything else being equal, properties that are older and have fewer credit-worthy tenants, for example, may have more risk, and therefore would be lower in price, resulting in a higher cap rate. Diversity of the tenants, length of leases in place, condition of the property, and location may also contribute to the risk premium and therefore impact the property’s value and subsequently its cap rate.

Contact 36 North Property Management

36 North Property Management is your best resource for sourcing, acquiring and managing investment properties in the Monterey County area, or to speak with us about our services, contact us today by calling (831) 484-4604 or click here to connect with us online.