If you're new to the real estate world, you might've heard the words "cap rate" tossed around. But what does that even mean and why does it matter for service members? This episode of From Military to Millionaire breaks it down.
So, what is a cap rate?
A capitalization rate, or cap rate, is the way to determine how much a property should be worth based on the income it produces. Cap rates move inversely to the purchase price. This means a higher cap rate equals a lower purchase price, and a lower cap rate equals a higher purchase price. To determine the cap rate of a property, divide annual net operating income (NOI) by the purchase price. To calculate your NOI, take the gross rental income and subtract all associated expenses, except for debt expenses.
What Does a Cap Rate Do?
Cap rates are used to express the market value of commercial real estate. They are divided into classes: A, B, C or D. Class A assets are the most prestigious properties, while Class D assets are the least. A “good” cap rate is subjective and will depend on the specific market you are investing in, the property type and your real estate strategy.
What Does that Mean for You?
When a group of investors (or battle buddies who know they should be investing but don't know how!) pool their money to purchase a substantial asset, they usually do so using syndication. Cap rates play a significant role in syndication investments, as they can impact the entry and exit sale price. While it is impossible to guess exact cap rates in the future, being an expert in cap rates can help you make highly educated guesses. It’s essential to be an expert in cap rates when making an investment like this to prevent getting screwed. You should never use a cap rate as the deciding factor for whether or not you purchase a property. Instead, use it as one of many tools in your decision about buying a property.
Level up your finances!
David Pere is an active-duty Marine who is on a mission to educate the military community about financial readiness. Most people hear that term and roll their eyes, but Pere wants everyone to know that readiness can be achieved – without a lot of effort. He teaches personal finance and real estate investing to service members to help increase savings and increase their chances of achieving financial freedom.
Want to learn more about Pere? Check out the Military to Millionaire website, and connect with him on Instagram or Facebook. Subscribe to his YouTube channel here! Take a look at David's book – The No B.S. Guide to Military Life here.
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