What is the Capitalization Rate?
How Does the Capitalization Rate Work?
Let's say Jane Doe buys a house to rent out for extra mortgage at 5% to pay for it, meaning her payments are $536 per month, her property work out to $165 a month, and the insurance on the place runs $60 a month, for a total outlay of $761. She rents the house out for $1,000 a month.
Using this information and the formula above, we can calculate that Jane's capitalization rate for this property is:
Capitalization Rate = (($1,000 - $761) * 12 months)/$100,000 = 2.868%
It is important to that capital improvements such as a new roof or carpeting are not included in the cap rate calculation. Only operating expenses are included.
Why Does the Capitalization Rate Matter?
Capitalization rates allowinvestors to place values on income-producing properties. The formula is also a way to estimate what similar income-producing properties should sell for.